Fed and Brexit

Rhetoric from Fed Governors this week, together with the release of fairly hawkish minutes from the April FOMC meeting, seem to have convinced markets that the next hike in the Fed funds rate will come in June.  That's very likely true, although the FOMC minutes give off an odd sense of having been written in a different era. Some of the recent domestic data, particularly relating to the all-important jobs market,  has been a little weaker than in previous months. Moreover, the FOMC's assertion that the headwinds the US economy faces from events overseas had begun to weaken now seems questionable.  Oil prices have rebounded sharply and China's economy continues to slow.

It may be that neither of those developments will deter the Fed from moving in June -- but what about Brexit?  The FOMC meets just a week before the UK's June 23 referendum on whether to remain in the European Union. It seems as if the vote will be a close one,  although the fact that the "Leavers" are already musing about a second referendum suggests they're not optimistic about how the first one will go. Will uncertainty on that score prompt the Fed to keep rates on hold for a little longer?

The Brexit debate has been short on light and long on heat, including a remarkably stupid invocation of Hitler by Boris Johnson, who really ought to know better. In terms of the economic consequences, various authorities have chimed in with warnings of the dire impact that Brexit would have, including Bank of England Governor Mark Carney and the IMF, which portrays the range of possible outcomes as "bad to very very bad".

In truth, nobody knows, because it's hard to come up with any precedent for what the UK is thinking of doing. In the long term it's quite possible that Brexit would make very little economic difference. Apart from a few crazed souls who pine for the days of the British Empire, even the Leave side is very clear that it would seek to keep the UK within the EU's free trade and financial markets: it's the moves toward political integration and the lack of accountability that they profess to dislike.

The short term, however, might be a different matter.  If there's a vote to leave, the UK can't just wake up on June 24, clear out its locker in Brussels and go home.  There's an enormously complex relationship to unravel, and new arrangements to be put in place. Although at the end of the day the remaining EU members are unlikely to shoot themselves in the foot by taking a hard line with the UK over free trade and financial markets, a period of uncertainty, possibly prolonged, will be unavoidable.  The weakness in Sterling since the referendum campaign began is a clear indication of how markets feel about this, and in the aftermath of a vote to leave, things would only get worse, at least for the short term.

Will that market uncertainty stay the Fed's hand?  It's unlikely that the Fed would want to give the impression that US monetary policy is being dictated by a bunch of xenophobic Brits, so if the Fed does decide not to move next month, expect any mention of Brexit to be mixed in with references to setbacks in the US jobs market and suchlike. A rate hike in June is still the way to bet, but it's by no means certain -- and a lot may happen over the next four weeks.