4 reasons why the US economy is so sensitive to Brexit-like shocks

As the market continues to absorb the news that Great Britain wants to leave the European Union, analysts say that the only certainty these days is uncertainty. And this uncertainty is echoing through economies around the world.

Even though the US has limited direct exposure to the UK, its markets have plunged and its economy appears to be at risk. Economist Ethan Harris and his team at Bank of America Merrill Lynch say that the US economy has become particularly vulnerable to confidence shocks in this atmosphere of uncertainty. They identified four reasons for this:

(1) Household deleveraging cycle

Household debt as a percent of disposable income declined to 106% in the first quarter from its peak of 135%, according to Harris. “Without the backstop of leverage, negative shocks will prove more painful and persistent, leaving households and businesses more risk averse,” he wrote.

(2) Limited fiscal and monetary policy ammunition

At this point, the Fed has limited tools to provide further accommodation, given that interest rates are at historic lows. Harris added that because of discord in Washington, fiscal policymakers will be slow to backstop growth against risks of an economic shock with robust spending. “This suggests that uncertainty shocks today threaten to exert a bigger drag than at the early stages of the recovery where there were more policy tools,” he wrote.

(3) Low-growth recovery

While the US economy has hit a low 4.7% unemployment rate as the stock market has hovered round new highs, the underlying economy is not strong as the jobless data suggests, according to Harris.

This has particularly impacted businesses, where investment has failed to recover its share of the economy. “Weak growth has left businesses unsure about the outlook and more concerned about the US economy’s vulnerability to global risks,” he wrote.

The Orange Book of CEO economic comments, published by Bloomberg, shows that peaking mentions of “uncertainty”—including during the 2012 fiscal cliff debate—aligned with a capital expenditure slowdown.

(4) Global interconnectedness

“External shocks have characterized this recovery, including the Eurozone crisis/Grexit, the recent Brexit vote, fears of a China slowdown and renminbi devaluation,” Harris wrote. “The US has become more sensitive to these external risks: not only is the US the most open it’s ever been, but also global financial markets have become correlated with each other.”

The European debt crisis is one example of an international shock that impacted the US, according to Harris.

And it could get worse

Harris added that there is a long list of other factors that could add to Brexit shock, including the US election uncertainty—especially added contentious rhetoric—and continued concerns about China’s rising debt levels and the volatility in oil prices. This all comes amid a debate about the effectiveness of global central bank policy and global productivity growth, he said.