07 Jul Brexit & Footwear
We are rather humored by the global market hysteria surrounding the Brexit. Why? According to World Bank stats, Britain accounts for less than 4% of global output and its exports to E.U. states account for 14% of its GDP; meaning even if new trade barriers increase between the E.U. and U.K. their trade accounts for less than .5% of total global trade. When you look at Brexit’s economic impact in this way, the global economic panic has more to do with traders’ and speculators’ banter than actual economics impacting real goods and services…but when has that stopped traders?
The pound volatility and devaluation are a short-term concern. The currency remains a global hedge for governments looking to balance their portfolio of euros and dollars. If China’s economy were stronger, one would see a move by Beijing to push the yuan forward to make it a top three trading currency. As it stands now, China is in need of a cheap RMB to help its manufacturing sector. The bigger concern than sovereign debt is that private equity investments into European companies will be on hold due to confidence concerns – which means we do believe there may be some continued Fx volatility until we have a clearer picture of who will lead Britain after Prime Minister David Cameron officially steps down. There is also uncertainty surrounding Scotland’s potential departure from the U.K. in order to stay in the E.U. That means a stronger dollar over the rest of the year as governments move relatively more debt to dollars than pounds in coming months, and it means a U.S. interest rate hike is unlikely until late in the year (if at all). In the long term, we do not see parity with the dollar, but rather we hypothesize Fx rates settling in around 1.30-1.35 dollars to per pound by year-end depending on political stability in Parliament.
For Britain, a declining pound means their exports will be cheaper for European consumers, which could help offset the pain from any E.U. tariffs that might be reinstituted after the official exit. If one looks at the E.U. economy now and into the future, it would be quite foolish to raise any new harsh barriers to trade. As current tempers in Brussels fade and reality sets in, there could easily be negotiations in the coming years to ensure customs and trade barriers, work visas, and many business standards remain close to current policy. This is all the more likely since an official exit is a minimum of two years away from now. To that point, as we move further away from the emotion of the vote and as Europe continues to feel economic pain, it could be assumed that Britain’s official exit date from the E.U. may be slow-walked to over a decade to ease economic uncertainty and soft land the exit.
In terms of U.S. – U.K. trade, there is a great amount of support from both parties for Britain economically and politically as one of our oldest allies. With the number of years it will take for an official exit from the E.U., U.S. officials can come to terms on a trade agreement with the U.K. outside of the current Trans-Atlantic Trade & Investment Partnership (T-TIP) currently being negotiated. Just last week, House Speaker Paul Ryan and House Ways and Means Committee Chairman Kevin Brady voiced support for the immediate launch of free trade agreement talks with Britain to ensure an agreement is in place once the process of exiting the E.U. is complete.
Already weakened, the Brexit will certainly keep the euro to dollar exchange rate at levels just above parity over the next year if not more. For the European economy, a U.K. exit is obviously not a welcome sign. This takes away a faster-growing state from the union and one that is a large market for E.U. member states. The Brexit only portends that a weak recovery in Europe becomes harder to revitalize, and policymakers at the European Central Bank will have a tougher time trying to find ways to stoke aggregate demand and inflation on the continent without Britain.
Politically, Brexit of course paves the way for other states to try and leave the E.U., putting more pressure on economic institutions and policymakers – one which foreshadows the end to the aggressive days of stringent debt to GDP ratios clamping down on European states so they don’t spend too much and only find themselves in bigger trouble in the future. Rather, Brussels may have to ease up on many of the harsher economic measures they have been enforcing over the past five years to ease grievances of states that may be looking to leave. To that point, rather than stop all progress, the Brexit may make it easier for American trade negotiators to move forward on T-TIP. European negotiators will be less likely to be stringent on protections they want and more focused on showing they can accomplish something major that benefits member states; helping keep states in the fold for now. Lead E.U. negotiator European Trade Commissioner Cecilia Malmström has already indicated publicly a willingness to provide key concessions in the hopes of finalizing an agreement with the Obama Administration by the end of 2016.
At retail across Europe, this entire saga will certainly cause a drop in consumer confidence and spending as people will fear the worst and look to pull back. Expect a footwear inventory glut over the next few months at a minimum in most European markets. Although, again, we feel as the political situation becomes clearer in Britain and Brussels over how the Brexit will be handled and who will be in key leadership positions, retail sales across Europe will get back on track by the end of the summer.
Footwear sourcing and supply chain teams should expect Brexit to help keep prices contained on many footwear raw material costs over the next six months. Oil dropped on the Brexit news, stopping a small rally, and the weakness in European demand and slower Chinese manufacturing, among other issues, means prices for cotton, synthetics, and rubber will continue to remain at low levels as will shipping costs. FDRA members can consult our monthly commodity report in our sourcing bulletin (click here for an example from 2015 if you have not seen it) for in-depth details on a number of footwear input prices and forecasting to ensure your prices from suppliers meet current raw material cost realities.
Overall, the Brexit does more to shock our sense of what the West understands (often falsely) to be global order than shift European economics. This certainly does hurt consumer confidence and stymies already-weak inflation in Europe, but a stronger dollar means America’s economy could pick up as US imports will be cheaper – helping drive up consumer purchasing power by the fall. Likewise, lower input costs for footwear could help offset rising labor costs in China and Vietnam, the top suppliers of footwear to America.
Europe’s largest economic problem remains political leadership – until investors and citizens there have confidence that officials in Brussels and London can steady the ship the economy will continue to have an anchor slowing it down. That confidence must be in economic policy that both citizens and member states think will help grow economies and increase disposable income. It must also be political policies that remind everyone why the E.U. was created in the first place as well as provide a new vision to why Europe should remain united to prevent more member state exits. With the centennial anniversary of the Battle of the Somme, a resurgent Russia, and the continued threat of radical Islamist terrorism inside the E.U., issues abound for Brussels to get it right. A bit less bureaucracy and a bit more leadership can get it done. While unraveling bureaucracy in the heart of where it was perfected won’t be easy, Brexit may have provided just the jolt to wake European leaders from their status quo slumber and start figuring out a new way forward.
Andy Polk is Senior Vice President at FDRA. Prior to FDRA, he served as foreign policy adviser to U.S. Rep Sue Myrick where he worked with Members of European Parliament on a number of key transatlantic issues. Polk earned his masters degree at the London School of Economics (LSE). While studying in London he and obtained key insights to British and European economics. Feel free to email him with comments, questions, or further insight into the geopolitics of Brexit.