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By New_Deal_democrat June 28, 2016 11:24 am
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Why Brexit is "a fire across the river"

My co-blogger Bonddad has highlighted an article by Fed President Lael Brainard on the negative effect that a stronger US$ has on the economy.  The primary concern is that a weaker British Pound, and Euro, will exert further downward pressure.

My difference of opinion can be summarized as the Scottish jury verdict, "not proven."  It is certainly true that *IF* there is a further big move by the US$, and it lasts, that will exert contractionary pressure on the US economy.  But I am not at all sold that any such move will be big enough to make much of a difference.  Here's why. 

Suppose you *know* the the Pound will decline against the Dollar.  Why would you wait a month or two or six before acting on that insight, missing that much of the down move?  You'd make you investment decision *right now* to try to capture all of the move, wouldn't you?


But everybody else has that same insight.  And everybody else also makes their decision right away.  The result is that the move that you thought was going to take 3 or 6 or 12 months takes place today.

That is what we saw with the "taper tantrum" in 2013.  Since everybody expected long term interest rates to rise as the Fed tightened, everybody made their investment moves right away, with the result that the long term bond made most of its move in just one month (June 2013):

And so now let's check out the chart of the British Pound vs. the US$ for the last week:

The big move was virtually instantaneous Friday morning.. Since then the Pound has gone sideways.  While the bottom isn't necessarily in, barring new and worse developments out of Europe, I would expect the Pound in the next few months to fluctuate about its value at the bottom Friday morning.

Meanwhile, here is the US$ vs. the Euro:

See that little blip at the far right?  That's the reaction to Brexit, as the Euro fell from $1.14 to $1.10, well within its range over the last several years.

Here's the spot price of the US$ agains major currencies:

Yes, there has been a move up, but well within the US$'s 12 month range.

Further, while a strengthened US$ is a headwind, the lower interest rates that this year's annual Europanic is bringing are a boon.  In fact, for a while yesterday the 10 year US Treasury tied its all time closing low of 1.43%:

Meanwhile, 30 year conventional mortgage rates are also closing in on record lows.  Here's a 5 year graph through last Friday:

And here are the updated rates as of Monday, from Mortgage News Daily:

These rates, which are only about 0.15% higher than the all time lows, are only going to help the housing market, which has already set several post-recession records in the last several months.

As of Friday, corporate bonds have not followed suit, although their yields haven't risen either:

If there is something noteworthy once the daily yields for Monday are published, I will update.

But I continue to see Brexit as "a fire across the river," that should not have more than a minor effect on the US economy. 


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