Brexit – risks of Britain leaving EU made Fed more cautious

Slower job growth and the risk of the UK leaving the European Union were cited by the Federal Reserve as it kept the lid on any interest rate rises this month.

The US central bank kept the target federal funds rate between 0.25% and 0.5%, in a widely-anticipated move as a range of factors are weighing on the outlook of the world’s largest economy.

Central banks from Japan to Switzerland are warning about the possible effects on markets if Britain votes to leave the EU and are taking a cautious line ahead of the vote.


Brexit Risks

Fed officials have been raising the issue of Britain’s EU referendum in recent weeks, but on Thursday we got the clearest signal yet that the central bank believes there is a real risk to the US economy if the UK votes out.

“Brexit, the upcoming UK decision on whether or not to leave the European Union, is something we discussed, and I think it’s fair to say it’s one of the factors that factored into today’s decisions,” Fed chair Janet Yellen said in a press conference after the meeting.

 “Clearly this is a very important decision for the United Kingdom and for Europe. It is a decision that could have consequences for global financial markets. It could have consequences in turn for the US economic outlook.”

Brexit risk is exerting influence across asset classes. US stocks have tracked European equities lower over the last week, while the VIX – the fear gauge – has risen to its highest in four months. Meanwhile, Treasury yields and other government bonds are rock bottom as investors seek shelter.

Jobs Slowdown

May’s non-farm payrolls figure came at 38,000, the weakest pace of expansion in five years. It meant the average pace of jobs growth in the US over April and May was just 80,000. Yellen said that while recent data was “disappointing”, policymakers expect the labour market to continue to expand over the next two years.

The Fed now expects the unemployment rate to fall to 4.7% this year and then down to 4.6% in 2017.

Rate Forecast

Yellen reiterated that there is no timetable to raising rates – “no pre-set course”; and that every meeting is a live one, meaning a hike in July is still on the table.

“The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run,” the Fed said. “However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.”

Fed funds futures trading points to less than a one in ten chance that the FOMC will move next month, rising to one in three by September. Most analysts expect at least one 25 basis point increase this year – however a black swan event (such as Brexit) could put paid to this notion.

Despite scaling back its interest rate projections the Fed still envisages one to two quarter point rises this year, down from the four predicted in December.

US growth is expected to slow, with the forecast for GDP expansion dropping to 2%. The outlook for inflation rose to 1.9%.

Central Banks

The Fed was not the only central bank in action. While its caution soothed volatile markets, the Bank of Japan’s inaction had the reverse effect. The yen surged beyond 104 against the dollar and the Nikkei dropped further into the red after the Japanese central bank chose to stand pat on monetary policy.

Thomas Jordan, the head of the Swiss National Bank, warned of Brexit turmoil in the markets as the bank left rates unchanged.

Meanwhile, in a widely expected move, the Bank of England left interest rates on hold and issued even sterner warnings about the possible impact of a Brexit on the UK economy.

Central banks are on alert for a Brexit and are apparently in close communication to respond - a flood of liquidity could be the immediate response.

Added market volatility means increased opportunity but also more risk. To reflect this, ETX Capital may be increasing margin rates on certain markets.