On Thursday, June 23, 2016, UK voters confounded expectations and the dire warnings of many politicians, business leaders and international non-governmental economic organizations by choosing to leave the European Union.Below is a summary of our initial thoughts on how the markets may respond, and the challenges and potential opportunities that we see going forward

Yesterday’s vote will create a noticeable increase in volatility in financial markets. The Sterling will probably decline, and UK interest rates are now not likely to change for some time, as this decision could prove a big hit to investors’ confidence.

Markets do not like the unknown, and a Brexit vote presents a huge amount of unknowns: not just questions about how this situation is going to play out, but even who is going to be dealing with it.

Although it’s difficult when markets are in the midst of this sort of volatility, we think it’s important, from an investment perspective, to keep a long-term focus. We think there may be some opportunities in the coming weeks and months from this upheaval because some otherwise attractive assets might be caught up in the melee.

What will the implications be for international markets?

In general, we consider this a risk-negative result. That means we would expect “risky” assets such as equities to experience volatility as there will be a flight to quality to assets perceived as less risky. 

We would expect to see some ramifications on the weaker economies in the eurozone and wider EU, with peripheral European bond spreads likely widening, and I would expect the euro to go down—although likely not as much as the pound—as people question the future of the EU project.

Europe does not rely on the U.K. as a market for exports to the same extent

If the financial services industry in London were displaced, over time it might actually bring business to other European financial centers.o   Overall, we think it will be negative for Europe's economy, but perhaps not to the same extent as the U.K. itself.

Implications for Britain

o   The U.K. is currently in the latter stages of the mid-cycle phase of the business cycle. Business activity and sentiment have weakened ahead of the vote, but consumer demand is holding up and the economy remains in a slow but steady expansion.

o   The vote to exit will likely hurt business sentiment and investment immediately.

o   The U.K. relies on exports to other EU countries for nearly half of its exports, but the preferential trade access the country enjoys as part of the EU could be eliminated.

o   This uncertainty is likely to slow economic activity in the near-term. We are not sure whether it will be enough to shock the economy into a recession, but I certainly expect it would be a negative short-term event for the U.K.

Implications for the North American Economy

The vote to leave likely has little direct impact on the U.S. economy over the long term. U.S. economic trends are heavily driven by the U.S. consumer (roughly 70% of GDP), which continues to benefit from tighter labor markets and rising income expectations 

The UK accounts for a modest 3% of total US trade and an even lesser 2.5% of Canadian trade, suggesting a minimal direct risk to the North American economy

While business activity has moderated some of late, the underlying trend there has remained solid as well. As a result, our U.S. macro view has not changed—the U.S. continues to experience a mix of mid- and late-cycle indicators, and the odds of recession remain low.o   The most immediate impact on the North American economy will come from the financial market volatility that we are seeing in the aftermath of the vote

The Federal Reserve has been hyper-aware of global economic risks, and a Brexit qualifies, which rules out a July rate hike. A move by December remains a reasonable possibility

What Happens Next?

David Cameron announced he will step down from his post by October.

The Bank of England’s contingency plans kick in – clearly, there will be no rate hikes for the foreseeable future

The UK will have two years to negotiate a deal with the EU

The UK job market would likely suffer, particularly financial services (a sector which accounts for 8% of British GDP)

The City of London’s future as a global financial centre is now in question, and a number of global banks could potentially relocate some of their operations out of the UK

Foreign investment may decline as access to other EU markets could become much more limited. British goods trade with the EU account for 45% of exports and over 50% of imports

The Bottom Line

Given the size of the UK economy (9th largest in the world, 2% of global GDP) and its small share of trade with Canada & US, the uncertainty and its impact on financial markets may be the biggest negative at the momento   The broad declines in equities, commodities and bond yields globally point to further downside in near-term global growth prospectsBrexit is about a trade deal and political arrangements – the biggest loser from Brexit will be the UK itself