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US markets drop sharply after ‘Brexit’ vote increases global recession risk

By Don Lee and Jim Puzzanghera • Jun 24, 2016 at 3:00 PM

WASHINGTON — Major U.S. stock indexes plunged Friday morning following a large-scale global selloff overnight in the wake of Britain’s vote to leave the European Union.

The Dow Jones industrial index plummeted 500 points, or about 3 percent, in early trading. The broader Standard & Poors 500 index and the technology heavy Nasdaq composite also were down about 3 percent in early trading.

The U.S. market drop followed a decline of nearly 8 percent in Japan and somewhat smaller but widespread losses throughout Europe as investors awoke to assess the fallout from the “Brexit” vote.

World financial officials were on high alert Friday.

The Federal Reserve said it was “carefully monitoring developments in global financial markets” and was prepared to provide dollars to other foreign central banks to increase liquidity. The Fed said pressures in global markets “could have adverse implications for the U.S. economy.”

Treasury Secretary Jacob J. Lew said he also was watching the situation and was consulting closely with British and EU officials. He and other finance ministers and central bank governors from the Group of Seven industrial nations, which includes the U.S. and Britain, said Friday they were ready to take steps to stabilize markets because they “recognize that excessive volatility and disorderly movements in exchange rates can have adverse implications for economic and financial stability.”

The hit to stocks means even Americans who have not been monitoring the Brexit vote will feel a pinch in their 401(k) plans. Consumer and business confidence, which was just recovering from sluggish growth last winter due to China’s slowdown and falling oil prices, could also take a hit.

Sung Won Sohn, an economist at Cal State Channel Islands, said an expected interest rate hike this year by the Federal Reserve “is no longer on the table” due to the stronger value of the dollar triggered by the British vote and expectations that reduced demand caused by slower growth in Britain and Europe would hurt the U.S. economy.

“The U.S. central bank might have to cut the interest rate back to zero if economic and financial conditions worsen beyond expectations,” he said.

A closely watched barometer by the CME Group futures exchange said Friday that there now was no chance of a rate hike in July, after putting the odds at about 12 percent before the Brexit results. The odds of a slight rate cut next month increased to 7 percent from zero.

Where things go from here is highly uncertain, but the economic climate is rife with significant risks as a growing backlash against globalization threatens to remake the world economic order.

The latest setback comes at a vulnerable time for the U.S. economy as job growth has weakened and many are concerned about what lies ahead in a presidential election year.

Many economists predict that Britain will slide into recession as its decision to leave raises questions about its future trade and broader relationship with the EU.

By itself, a recession in Britain isn’t likely to have a big direct effect outside of Europe; the British economy is the fifth-largest but still accounts for only about 2.5 percent of world economic output.

Even so, it could do much greater global damage as the referendum results now set in motion what many experts expect will be a long, uncertain and politically tortuous process of Britain unhinging itself from the rules of the EU, especially the free flow of labor that has been a hallmark of the British economy.

Policymakers as well as investors are particularly worried that Britain’s move will be a catalyst for other secession movements in the EU, which could fundamentally alter the political and economic structure that has been in place for decades in the aftermath of World War II.

“With one fell swoop, the world order has been turned upside down overnight and where the chaos stops no one knows,” said Chris Rupkey, chief financial economist for Mitsubishi UFG Financial Group.

For the U.S., one of the biggest risks comes in trade. With the dollar strengthening against the pound and the euro, American manufacturers will face greater challenges in selling goods abroad.

Some U.S. business groups as well as analysts cautioned against overreacting to the situation in Britain.

Thomas J. Donohue, president of the U.S. Chamber of Commerce, said it was important for investors in U.S. businesses “to avoid precipitous action” until Britain and the EU negotiate the specific terms of the exit.

“American companies’ investments in Britain are worth more than half a trillion dollars, and many of those investments were made to reach not just British consumers but those in the European mainland as well,” he said. “We are committed to working with the U.K. government to ensure that the priorities of these stakeholders are taken into account in the debates that lie ahead.”

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