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Why the timing of this Brexit mess couldn't be worse for the world economy

Rayhanul Ibrahim
Jack Dempsey, Harry Houdini, and Benny Leonard get tangled up. (Image: Wikimedia Commons)

Britain’s vote to leave the EU came at a particularly vulnerable moment for the world economy, argues a new report from J.P. Morgan.

“You picked a fine time to leave, UK,” J.P. Morgan’s Bruce Kasman wrote on Friday.

Global corporate profits are falling

For one, corporate profits are already struggling, especially in the US. A separate report from Factset, on June 24, found that earnings for the S&P 500 (^GSPC) were already likely to decline by 5.2% in Q2 2016, even before Brexit occurred.

“[I]t will mark the first time the index has recorded five consecutive quarters of year-over-year declines in earnings since Q3 2008 through Q3 2009,” FactSet’s John Butters wrote.

Earnings have been declining for a while. (Image: FactSet)

All of this has caused JP Morgan to lower US GDP growth expectations from 2.3% to 2%, for the second half of 2016.

Emerging markets have too much debt

Emerging market economies are also already struggling, given that it has become harder to borrow over the past few years and that there has been an ongoing push to reduce corporate debt in these countries. These two issues had abated a bit over the past few months, given the weaker dollar and stable oil prices.

However, this lull is likely to end, given the dollar’s gain in strength and the generally increased financial market volatility in the wake of the Brexit vote. Essentially, if Brexit causes investors to become even more wary of risk, these countries could find it very hard to borrow the money they need.

And this isn't a problem for just the emerging markets, Many companies in developed markets get much of their growth from the emerging markets.

Policy makers may be tapped out

Lastly, Kasman notes that there is very little that policy makers can do in response to the turmoil caused by Brexit. Central banks have already brought interest rates down to near-zero, or negative. Adding additional stimulus in the form of quantitative easing — where central banks buy assets from banks, usually bonds, in an attempt to lower yields, and ultimately stimulate further demand — will be less helpful in this sort of environment, especially if the European Central Bank is the one to do it, Kasman argues.

Kasman does also note that the Fed will likely delay rate hikes further now, while the Bank of Japan will likely increase their quantitative easing programs. These decisions may help the world improve its growth rate again.

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