The UK’s vote to leave the EU shook markets globally.
Banks discussed plans to move their operations out of London, the recent Scottish referendum looks fragile, and general uncertainty permeates the UK business environment. US business owners are wondering how this commotion across the pond affects them. Though there are many small effects rippling out from the referendum, there are three areas that have the greatest impact on US small and mid-sized businesses.
Currency value changes
After Brexit, the Sterling Pound hit a 30-year low against the US Dollar (1.3 GBP/USD). The currency markets hammered Sterling because of uncertainty surrounding economic growth, the expectation that the Bank of England (“BoE”) would drop interest rates, and the looming trade negotiations with the EU and rest of world.
A deflated British currency has arguably the most direct effect on US businesses, particularly those that depend on the UK market for sales or supplies. British goods are now cheaper internationally, while the country’s buying power has decreased. US export manufacturers, particularly of industrial goods such as hydraulic motors and oil & gas refining equipment, may see stiffer competition from cheaper British competitors.
Outside of gold (that spikes with uncertainty), Brexit also drove down commodity prices. Analysts lowered demand forecasts in the EU and UK in the face of slower economic growth. Major commodities are also denominated in US dollars and thus became relatively more expensive (the dollar became a haven for investors as the US economy is seen as strong). This price drop puts even more pressure on beleaguered US mining and extraction companies.
The largest US export industries to the UK – aerospace, machinery and precious metals – could also suffer as the country’s buying power decreases with the value of their currency.
US Federal Reserve keeps interest rates low
Partially due to Brexit, the US Fed didn’t raise rates coming out of their May meeting. Seemingly allergic to any shadow of volatility, economists believe that the Federal Reserve won’t raise rates this year at all… Simultaneously, capital shifted from riskier assets into US, UK, Japanese and German government bonds. This flight to safety drove bond prices higher and yields even lower. Nearly 80% of Japanese and Germany bond yields are now negative! For US businesses, particularly small businesses, this means it’s a borrower’s market. Capital is not quite historically cheap, but pretty darn close, as banks and investors chase yield.
No US industry enjoys low rates quite like construction. 45% of economists that the WSJ recently polled said the construction industry would benefit due to low rates that reduce the costs of financing projects and of mortgages. Only 4% of economists thought construction would be harmed.
For US financial services companies, the news is less positive. Low rates eat into the interest margin that banks earn on lending. They also put pressure on US insurance companies, which are vulnerable to changes in interest rates as their earnings are generated from investing insurance policy proceeds in stocks and bonds. They now must move into riskier assets to earn the same return.
New UK trade laws
UK sovereignty comes with a rewrite of their international trade agreements. This monumental task includes much uncertainty about UK and EU trade relations (plus the movement of workers, but that’s a separate topic). Will the EU want to punish the UK during negotiations to set an example, showing countries with strong independence movements (Frexit anyone?) that the consequences of leaving are no fun? Or will they keep mutual benefit in mind and collaborate with UK officials? It’s hard to say until the negotiations start…
Along with negotiating new trade laws with the EU, senior UK officials have begun preliminary trade talks with the Obama administration about a US / UK trade deal. The goal is to reduce tariffs and other regulatory barriers the UK participated in as part of the EU. The US is the UK’s most important trading partner, importing and exporting approximately $58 billion and $56 billion in goods a year, respectively.
Many US companies use the UK as their entry point into the EU market. This may change depending on how trade agreement negotiations shake out between the now independent entities. In an interview with Fast Company, Cody Townsend, the cofounder of Arcade Belts, stated “As a small retail business developing European distribution, we’ll now have to have separate European distribution, meaning higher shipping costs, lower margins, and increased workload.”
Brexit will profoundly impact the UK and European Union, but likely won’t have a huge effect on the US economy. For US businesses without significant activity in the UK and EU, there probably won’t be much of an effect at all. Interest rates may stay lower a little longer, but they’ve been incredibly low for the past 7 years, and helped drive the proliferation in small business lending. If your company does business with the UK or EU, look out for new trade agreements over the next couple years. But know that both entities are economically incentivized to have strong, fruitful relations with the US. Hopefully the rationale wins out over the emotional in this ongoing saga.
[…] EU, look out for new trade agreements over the next couple years,” wrote trade finance firm Harper Partners. “But know that both entities are economically incentivized to have strong, fruitful […]