What to expect when you’re Brexpecting

Commodities, currencies and government bonds are in for a rough ride should Britain vote to leave the European Union.

As Britons head to the polls to cast “stay” or “leave” ballots, the outcome, expected late tonight, is too close to call.

But what is clear is the consequences a Brexit would have on global growth and investors’ portfolios.

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The U.K.’s growth prospects would shrink by 0.3% to 0.5% of GDP a year, says David Lafferty, chief market Strategist at Natixis Global Asset Management. While that shrinkage may not seem like much, for an economy the OECD already predicts will only grow by 1.75% this year, it’s significant, he adds.

“Forecasts would be downgraded everywhere,” says Francois Bourdon, Fiera Capital’s chief investment solutions officer, but by how much would depend on how the situation unfolds. The OECD currently projects the world’s economy will grow by 2.4% in 2016.

The global growth downgrade would affect Canada too, says Bourdon. There are implications for our dollar, exports and major industries.

The U.K. would be saddled with most of the pain of a Brexit, Lafferty adds, followed by the EU and then the global economy.

“If an economy was growing at 4% or 5% real, it would be able to handle a 50-basis-point or 1% shock,” he says. “But the entire global economy is more susceptible to geopolitical risk, because real growth rates are just lower.”

Should the U.K. decide to leave the EU, what would follow is a short-term market correction and a period of uncertainty lasting months or years as the two geopolitical powerhouses negotiate the terms of departure, say experts.

Economists are positing two exit paths: a smooth Brexit and a rough one.

In Brexit gone bad, the country may not have access to the European market – which would cut 4% or 5% from Britain’s GDP, says Bourdon. In the smoothest version, he says the departure would barely be felt.

The reality would likely lie somewhere in between.

“The EU is going to make the withdrawal process as painful as possible on the U.K., up to a point where it affects [the EU’s] own economy,” says Lafferty. It’s in the EU’s interest to make withdrawal difficult, so as to deter other countries, such as Italy, Spain and Portugal, from using the U.K. as a blueprint for their own withdrawals.

Read: U.K. jobs with Canadian firms at risk over EU, says Morneau

Equities

“In the event of a vote to leave, we could be setting up for one of the best opportunities to buy U.K. and European stocks in a long time,” says Lafferty.

He notes U.K. stocks are already trading at a relative discount to their American counterparts – the S&P 500 is trading at almost 18 times forward earnings while the FTSE is trading at 16.5 times. A Brexit vote could trigger an immediate sell-off of U.K. equities, increasing the discount, he says.

“It’s almost certain the market will overreact to the news, and that could take what already looks like a relatively attractive valuation and make it a pretty good valuation,” he says.

“These businesses will face some headwinds, but their prices are going to get affected a lot more than their underlying fundamentals will,” he says.

Over the long term, Brexit’s impact on British companies will depend on the negotiations.

Companies with offices in London’s financial district could be forced to move to Germany or France to do business with the rest of the continent, says Bourdon. This would also affect Canadian banks that serve European clients from London offices, he notes.

Depending on the U.K.’s level of EU market access, British companies’ cash flows and earnings could be affected. But Lafferty says if a firm is a good fundamental investment before the vote, it should be afterward, too.

Read: Brexit means discounts for U.K. companies

Bonds

Brexit would send already-low bond yields even lower, says Lafferty, but he isn’t concerned about its impact on the global bond market.

“You still have massive accommodation from the European Central Bank and the Bank of Japan,” he notes. The ECB’s bond-buying program would help stabilize the market, Bourdon adds, though the spread between corporate and government bonds would widen.

Right now, Lafferty favours investment-grade high-yield bank loans over sovereign bonds. Government bonds from safe countries, such as Germany, the U.S. and Canada, would see their yields drop, adds Bourdon, while those of countries that could be next to leave – such as Italy, Portugal and Spain – would increase.

Read: Spain avoids EU fine despite another deficit

Central banks

In a Brexit scenario, “central banks would be back in play as saviours, and would probably provide liquidity as needed,” says Bourdon.

The Federal Reserve and the Bank of England would likely delay any planned rate increases, say the economists. In fact, the Bank of England’s first policy decision after a leave vote would likely be to cut its key interest rate from 0.5% to zero, says Bourdon.

Read: Don’t let Fed meetings rattle long-term focus

Currencies

Earlier this week, the pound rose 4% as traders seemed to shake off Brexit fears, says Lafferty. While a remain vote would continue the modest rally, earlier gains are setting up the pound for a steeper correction should Britain vote to leave, says Lafferty.

Bourdon expects a 10% drop in the pound’s value in the days after a vote to leave. He says the euro would also be affected, as would emerging market and riskier currencies, such as the Canadian and Australian dollars, and the Mexican peso.

In a Brexit scenario, Britain may devalue the pound over the long term to help its exporters compete, especially should the country lose unimpeded access to the Eurozone’s common market, Lafferty adds.

Read: Pound will tank if Britain leaves EU: Soros

Commodities

A Brexit would push commodity prices lower, as investors price the impact of lower EU and British GDP into demands for raw materials, says Bourdon.

Oil prices would be sensitive to drawn-out exit negotiations, he says, and prices could hover between US$40 and US$50, instead of US$50 to US$65. On a positive note, a Brexit would be good for gold as investors look for safe havens.