Federal Reserve chair Janet Yellen has gone on record saying that a British vote to leave the European Union (or, Brexit) would have consequences that will ripple through the global economy and financial markets. Moreover, in a speech last week, Yellen confirmed that the fallout from a Brexit "leave" vote would indeed be considered during the upcoming FOMC meeting to be held June 14 and 15, which will culminate in an interest rate decision, saying, "A UK vote to exit the European Union could have significant economic repercussions." As of now, polls show the U.K. voters split fairly evenly with 50% saying they will vote in favor of a British exit and the other 50% saying they will vote to remain in the EU.
Earlier this year, the Fed raised its target Fed Funds Rate for the first time since the Great Recession, and many had anticipated a slow and steady series of rate increases, which have not actually materialized. In her speech last week, Yellen said, "If incoming data are consistent with labor market conditions strengthening and inflation making progress toward our 2% objective, as I expect, further gradual increases in the federal funds rate are likely to be appropriate." Currently, futures markets at the CME predict that there is a 98.1% probability that the Fed will leave interest rates unchanged at 0.50% in June and just a 1.9% chance of a 25 basis point hike to 0.75%. Futures markets are not pricing in any chance of a rate cut at the moment. If the Fed does not raise rates this month, its next opportunity to do so will be at its July 27 meeting. (See also: U.S. Labor Participation Rate at Record Lows. )
Brexit's Impact on a U.S. Rates Decision
While economic data in the U.S. has pointed to a modestly improving economy, with the headline unemployment figures clocking in below 5%, and with GDP growing steadily, some economists have warned that a Brexit could have an adverse effect here in the United States. Yellen has also remarked that a Brexit could change expectations and the appetite for risk among U.S. investors. Fed governor Lael Brainard has echoed Yellen's sentiment saying, "Because international financial markets are tightly linked, an adverse reaction in European financial markets could affect US financial markets, and, through them, real activity in the United States."
Some predict that a Brexit will spur a recession in the U.K. accompanied by high unemployment. The U.S. firms with large operations in Britain, and especially those in the financial sector are bound to see their stock prices negatively impacted as a result. In 2014 for example, U.S. companies invested more than $588 billion into the British economy. The Ford Motor Company (F) and Goldman Sachs Group (GS) have already announced contingency plans to scale back U.K. operations should Brexit occur. European markets could also feel a sting as a Brexit may undermine the stability and perceived robustness of the common economic zone, and encourage fringe countries such as Greece, Cyprus or Portugal to follow suit and leave as well.
Foreign exchange markets will also bear the brunt of a Brexit, with the U.S. dollar probably seeing an unwanted increase in value versus the British Pound, and some have also speculated that the euro could also fall in relation to the dollar as foreign capital from the UK and Europe alike flow into the U.S. A stronger dollar hurts exporters and might be seen as a countervailing force to the broader economic recovery. Higher domestic interest rates will only make the dollar look even more attractive as a place to stick foreign funds.
The Bottom Line
The upcoming vote for Britain to leave the EU, in a so-called "Brexit" is fast approaching with polls showing a near 50/50 split in the outcome. If a Brexit does occur, however, it may force Janet Yellen to put the curbs on future interest rate increases in the U.S. To be sure, she and other Fed members have voiced concerns over the repercussions a Brexit could have on global financial markets and the U.S. economy due to changes in sentiment and expectations - but also due to currency movements and fallout from a British recession. With futures markets showing a very high probability of no rate hike during this June's FOMC meeting, a 'Yes' outcome for Brexit may already be factored in.