Brexit voting...

Wall Street holds its breath on Brexit

Clinton, Democrats could suffer if U.K. voters pull out of EU, causing a global financial sell-off.

By Ben White

Wall Street is breathlessly on edge over the United Kingdom’s Brexit vote on Thursday, with many analysts fearing a major sell-off and possible global slowdown if the country votes to leave the European Union.

Many Democrats also fear a vote by the U.K. to leave the EU will suggest that a nationalistic, anti-immigration political wave that is also sweeping the United States could be much stronger than expected.

Current polls suggest the “Remain” side has a narrow lead in the U.K. But the referendum could swing either way and Wall Street analysts fear that a surprise “Leave” victory would send stock prices sharply lower, increase uncertainty about a complete unraveling of the EU and damage a United States economy that is barely growing and remains highly susceptible to outside shocks.

“My expectation is Remain wins,” said Jim Paulsen, chief investment strategist at Wells Capital Management. “If Leave wins there will be an immediate reaction with sharp losses in stock markets across the globe. Emerging market stocks will also be hit hard. Oil prices will decline significantly. The U.K. pound will decline significantly.”

The shock to the U.S. could be even greater because for months, polls and betting markets alike suggested that Remain would win fairly handily following stark warnings from leaders across the globe — including President Barack Obama — that a vote to leave the EU would be terrible for both the British and the global economies.

“An exit vote would catch investors flatfooted, as most of us are relying on local betting figures to conclude that Brexit is an unlikelihood,” said Jack Ablin, chief investment officer at BMO Private Bank. “Banks with London financial centers would bear most of the brunt of selling, as investors anticipate trading would shift to a euro-based city, like Frankfurt. We would expect a dollar and yen rally against the pound and euro weakness as capital shifts away from the region. It would be hard to predict how hard stocks could get hit since the blowback from the vote would play out over a couple of years.”

A strengthening dollar in the wake of a Leave vote could be bad for the U.S. because it would make exports more expensive, hurting companies that sell abroad. Some analysts also fear a contagion impact if European banks or big hedge funds struggle after a Leave vote, leading to the kind of loss of confidence and even flat-out panic that emerged during the global financial crisis of 2008.

Should U.S. markets suffer and bank stability come into question, a Leave vote could threaten growth in the United States, which clocked in at just 0.8 percent in the first quarter. Jobs gains in the U.S. are also slowing significantly.

Federal Reserve Chair Janet Yellen, in testimony on Capitol Hill this week, cited the Brexit vote as a significant risk to the domestic economy, though she stopped short of saying a Leave vote would cause a recession.

“I don't think that is the most likely case,” she said. “But we just don't really know what will happen, and we will have to watch very carefully.” The Brexit vote is widely viewed as one of the main reasons the Fed declined to raise interest rates at its meeting earlier this month.

A Brexit-induced slowdown would clearly be unwelcome news for presumptive Democratic nominee Hillary Clinton, who is counting on a solid economy and declining unemployment to drive her to victory in November over presumptive GOP nominee Donald Trump.

But beyond any economic impact, top Democrats fear that a surprise win for the Leave camp would suggest that a populist wave that opposes immigration and unfettered free trade may be stronger than polls on both sides of the Atlantic suggest. That would be good news for Trump, who has spoken in favor of Britain voting to leave the U.K.

“The Trump people will be overjoyed if Leave wins,” said Austan Goolsbee, a professor at the University of Chicago and former top economic adviser to Obama. “It would say that the same problems we have with accurate polling in the U.S. exist in the U.K. and that the populist element is much stronger than polls say.”

Goolsbee added that the Brexit vote in the U.K. has become essentially a “referendum on immigration,” with British citizens in favor of leaving arguing that the EU’s more liberal approach to migration leaves countries vulnerable to the kind of terrorist attack that rocked Paris last year. Leave proponents have also cited the recent mass shooting in Orlando to press their case.

Many analysts suggest that if a vote by the U.K. to leave the EU happened in a vacuum, it would likely produce only a small bout of market volatility as Britain attempted to re-establish trade ties with the U.S. and other nations. But populist sentiment is also rising in France, Italy and other European nations, and a win for Leave could spark a series of similar votes that could destroy the EU, an institution created to integrate Europe and avoid the kind of populist nationalism that led to centuries of war across the continent.

“I do think it would start a chain reaction of events that are very likely to blow the Eurozone apart,” said Goolsbee. “Many countries will say they want to have their own vote.”

The world is not likely to know the result of the Brexit vote until early Friday morning. There are no official exit polls being conducted and voting will remain open until 10 p.m. in the U.K., or 5 p.m. Eastern Time in the U.S. on Thursday, well after most markets close. U.K. officials say they will have a result “around breakfast time” on Friday, meaning U.S. investors will learn the results overnight Thursday night.

So any big impact would begin in Asian trading on Friday and then spread across the rest of the globe. U.K. Prime Minister David Cameron, who promised to hold the vote during a difficult reelection campaign, told The Financial Times this week that he believed a vote to remain would spark a relief rally.

“I think on Friday that businesses, wealth creators, job creators will think: Britain has made a decision, let’s pile back into the economy and create jobs and opportunity, because it’s a great place to do business,” he said.

U.S. analysts believe a similar rally could occur here if Remain wins, driving away one big uncertainty that has been hanging over markets.

“If Remain does indeed come out on top, the dollar likely will dip a bit further against both sterling and the euro, while stocks and Treasury yields should rise slightly, as the remaining risk of Brexit drains from the markets,” Ian Shepherdson of Pantheon Macroeconomics wrote in a note to clients on Thursday.

Such a vote would also come as a big relief to Clinton’s campaign staff in Brooklyn, as another big economic wild card would be removed from the presidential campaign.