World Economy
0

Can US Weather Brexit Storm?

Can US Weather Brexit Storm?Can US Weather Brexit Storm?

The UK’s decision to exit the European Union may rock the overall US economy in coming months. But it isn’t likely to sink it.

Once the initial market turmoil abates, the “Brexit” decision will become the latest in a long list of headwinds contributing to the American economy’s sluggish growth. The US has powered through a number of overseas risks in the seven years since the recession ended and economists expect it will weather this one, too, allowing domestic concerns to again take center stage, WSJ reported.

The British decision is expected to hit the US economy in at least three key ways: It will strengthen the dollar, weigh on business confidence and tighten financial conditions. All of that will saddle American businesses and investors, particularly those with a strong presence abroad. American households, on the other hand, could see some benefit from cheaper imports and gas prices.

Over time, this could accelerate the US economy’s move away from manufacturing and exports and toward consumer spending and housing.

The dollar surged last week as investors fled the UK and Europe and poured into the relative safety of US assets. Greenback strength will likely persist, especially given worries about the UK decision fueling further disintegration of the EU.

 Gradual Damage

A sustained appreciation of the dollar curbs demand for US exports by making products and services more expensive to sell abroad. At the same time, it makes imports cheaper for US consumers, containing inflation and restraining wage growth.

It also undercuts global demand as borrowing costs rise for countries and firms that have dollar-denominated debt. And it pushes commodity prices down, weighing again on the US’s energy and metals sector.

Goldman Sachs economists estimate every 10% increase in the dollar shaves off nearly 0.6 percentage point from US economic growth. The Federal Reserve’s model shows gradual damage to the economy: In the first quarter after the dollar’s appreciation, growth is trimmed by only around 0.08%. After two years, about 0.75% will have been lopped off GDP.

Business confidence will also take a hit from Britain’s decision. Many economists predict the vote will send the British economy into recession and cause prolonged economic trouble for the rest of the European Union. The region has already struggled to escape from the legacies of the financial crisis. Bad loans still burden the financial sector, thereby smothering investment, and the average unemployment rate tops 10%.

Brexit adds to those problems by fueling economic and political uncertainty in the EU, which is the largest single export market for American firms. Thursday’s vote gave fresh wind to anti-Europe parties, raising the risk of a further breakdown of a union designed for decades to foster free trade and labor mobility.

  Slower Growth

Global market volatility tends to sour risk appetite among many US companies. Executives are more likely hold off on investing in new products, machinery and projects as they hunker down and wait for the post-Brexit storm to pass. That means a slower pace of productivity growth, also holding down wages.

Businesses “are very cautious right now,” said Chad Moutray, chief economist at the National Association of Manufacturers, a trade group. “This is just one more headache that manufacturers have to deal with.”

American business investment was suffering even before the UK vote because of slow economic growth, a strong dollar and falling oil prices. Private nonresidential investment fell 6.2% in the first three months of the year from the previous quarter and the vote could push it down further.

Also US stocks joined a worldwide selloff after the UK’s vote to leave the European Union fanned speculation that a divided Europe would put another brake on already fragile global growth.

  Gloomier Outlook

Federal Reserve Chairwoman Janet Yellen highlighted timid private-sector spending as one of her biggest worries during congressional testimony last week. “Private investment has been very weak,” she said. “That’s one reason productivity growth has been so meager.”

The riskier, gloomier outlook could raise the cost of corporate and consumer credit for some groups.

The premium markets require for investment-grade corporate bonds in the US, for example, rose in the wake of the referendum. Banks also become less willing to lend. Falling stock prices could also make capital more costly, forcing a recalculation of corporate spending as projects look less viable.

But the news isn’t all bad. The US economy, which has weathered repeated storms from Europe’s debt crises over the past four years, remains relatively healthy, or so it seems.

Investors clamoring for the safety of US government debt have pushed down yields, which move in the opposite direction as prices. That holds down interest rates and makes the Fed less likely to raise short-term interest rates in coming months. And that makes mortgages cheaper for American home buyers and homeowners looking to refinance.

Likewise, dwindling prospects for global growth and the stronger dollar push energy prices down, helping consumers save more at the pump. Oil prices fell 5% Friday.

The so-called powerful US dollar also means American consumers can buy more British and European goods with their dollars and travel overseas at a lower cost.

“I think it is unlikely the US consumer—which is driving this recovery—will be thrown off by Brexit in the short term,” said Megan Greene, chief economist for financial services firm Manulife.

“If there is contagion to the rest of Europe, however, then a US recession becomes more likely,” she said.

 

Financialtribune.com