Britain’s vote to leave the European Union will almost certainly have repercussions for the Federal Reserve. And the aftershocks could play out over days or months.
The severity of the fallout will become clear over three time horizons. On Friday, the Fed could act with its global central bank partners to shore up liquidity in markets, if needed. In the medium term, Brexit’s market effects could delay a rate increase, while in the longer term, secondhand effects of Brexit could bleed into U.S. economic data. Here’s what to look for at each stage.
The Fed had yet to react to the market turmoil as of 8:30 a.m. The central bank could seek to ease concerns by providing liquidity to market participants, or simply by stating it is prepared to do so. The Bank of England and the European Central Bank did just that earlier on Friday.
“To support the functioning of markets, the Bank of England stands ready to provide more than £250bn of additional funds through its normal facilities,” said Mark Carney, governor of the Bank of England. “The Bank of England is also able to provide substantial liquidity in foreign currency, if required.”
Added the European Central Bank in a statement: “The ECB stands ready to provide additional liquidity, if needed, in euro and foreign currencies.”
With liquidity provisions and “soothing talk” from central banks “it’s not hard to imagine a return to normality in the not-too-distant future,” said Roberto Perli, a partner at Cornerstone Macro LLC in Washington.
Near-Term Hike Delay
The fallout from Brexit could delay the Fed’s plan to increase interest rates in coming months, particularly if the dollar strengthens and uncertainty intensifies.
The British vote to leave comes at a time when Fed policy makers were already sounding less confident that a rate hike was imminent. Fed Chair Janet Yellen had been saying that an increase could be appropriate “in coming months,” but that language has been conspicuously absent from her speeches following a weak May jobs report.
Now, if markets are roiled and a flight to safe assets drives up the dollar and tightens financial conditions on a sustained basis, it could be even harder for the Fed to move.
Futures pricing discounted the odds of a rate increase and showed the probability of a cut running as high as 19 percent in both September and November as of 8:15 in New York on Friday. Investors on Thursday saw zero chance of a rate cut this year.
“To some degree, this means an unwanted tightening of financial conditions at a time when the U.S. economy is still quite mixed,” said Thomas Costerg, a senior U.S. economist at Standard Chartered Bank. “I think a rate hike would really, really look difficult, even with rebounding payrolls.”
The Fed has shown itself unwilling to tighten policy when the dollar is rising, said Guy LeBas, chief fixed-income strategist at Janney Montgomery Scott LLC in Philadelphia. Early this year, dollar strength and a risky global outlook kept the central bank on hold.