Archive for June, 2016

Brexit Blues

Ignoring everything but the markets, here is what yesterday’s vote to leave the European Union has meant for the world so far.

UK currency and assets

The pound has fallen by 7% against the dollar, over 10% against the yen, nearly 5% against the euro and by 4-6% against the Swiss franc and the dollar zone and Scandinavian currencies.

The FTSE 100 index has fallen by a little over 2% while gilt yields have fallen sharply back to the lows reached in the middle of the month.

Haven assets

In fact government bond markets are having a generally good time of it today with big rallies in Treasuries and bunds too. Lucky investors can lock in to a negative yield to redemption over ten years of -0.06% today in Germany, a new record low.

Gold has punched higher again and if it holds at its current margin above $1,300 will post its strongest close since the summer of 2014.

Risk assets

Correspondingly these have sold off. Other European bourses have fared rather worse than London with the Stoxx 50 down by more than 7%. Tokyo was off by almost 8% overnight while the North American exchanges are taking things more coolly, having lost about 2%. Conversely, emerging market indices in Europe and the Far East have outperformed in the down swing thus far. EM currencies are weathering things well too with the worst performer being the rand this afternoon (weaker by about 3.5%).

Credit spreads as measured by the iTraxx indices are markedly wider. Both the investment grade and high yield (“crossover”) CDS indices are back to levels reached in early March before the year’s opening panic had fully ebbed away. Peripheral eurozone bond yields have gapped wider to Germany too, with the Greek ten year hit especially hard and heading for a yield of 8.5%.

Other points of interest

Oil is off by about 4% – tracking the risk off environment but actually not an especially volatile result for the commodity (and at $48 or so per barrel it is still miles away from the $28-30 lows witnessed back in January). It is also of passing interest that palladium has fallen today and that both platinum and silver have rallied far less strongly than their glittery yellow big brother.

Verdict on the Brexit Blues so far

There have been several moves consistent with a broad-based risk off, flight to quality mood, of which some have been more dramatic than others. On the currency and other fronts however the drama has not been as gripping as some were predicting, with sterling falls of over 20% and so on. This could represent nothing more than a staged decline – as more troubling news emerges into next week, for instance. Or it could indicate that much of the outcome was already priced in, or that markets are simply not so concerned about it as some thought that they might be.

Finally, there have been some gruesome economic projections in circulation today with more than one house expecting a recession. To reiterate: NOBODY KNOWS what the economic impact of Britain’s vote will be. At present it looks as though negotiations on EU withdrawal and (presumably) global trade agreements etc. are to begin in the autumn. It is the handling of those which arguably presents the greatest known risk to the country’s economic future.

24/06/2016 at 4:06 pm

Central Bank Watch

Central bank activity has been a linchpin feature of market activity in recent years. Rather than following rate trajectories and getting on with life, markets have been paying such attention to every last detail of bankers’ announcements and emergency programmes around the world that there have been some curious butterfly effects. In 2013 for instance the Fed announced that one day, quantitative easing would come to a halt. Now this programme had exhibited next to no economic effect on the US itself. But it weakened the currency of Brazil to such an extent that rates went up to defend against import price inflation, thereby contributing to that country’s recession and associated woes.

So what have central banks been up to lately, and what might come of it?

In the US the Fed has attracted criticism for its confusing guidance ever since it bottled tightening policy last autumn. The most recent statement from Chair Yellen said she was “cautiously optimistic” on prospects for the US economy, and she has said on several occasions that she would rather point people towards indicators which the Fed follows than give specific commitments to policy decisions in advance, which is understandable. But it has created uncertainty: some observers find signs in the data that the Fed is falling behind the curve, while others see no case for any more tightening at all this year. Markets are pricing in no move over the summer – which conflicts with Fed briefings as recent as 12 days ago – but expect the target rate to have risen to 0.75% by the end of 2016. Bloomberg summarized the situation well in a piece headlined: “Yellen Data Dependence Leaves Investors Dazed And Confused“.

For investors, this means continued uncertainty over the imminent path of US interest rates and that is not a comfortable situation for markets to find themselves in. Today’s sell off in equity on both sides of the Atlantic is, in part, a reflection of this. As to what will actually happen it is plainly anyone’s guess though if oil remains at the $50 level the deflationary contribution from energy will fade in August, core inflation remains above 2% and last week there was a positive data surprise in the form of a 4.7% unemployment rate (down from 5% and a new post-Great Recession low). Fundamentals aside, however, the Yellen era has been characterized thus far by uncertainty and that remains the key watch point from the Fed at present.

Over at the ECB talk on monetary measures has quietened down, though a noteworthy kilometrestone was reached this week when the bank began its latest phase of QE through buying corporate debt. Mr Draghi has instead been opining on supply side reform and keeping a studied silence on some issues which might possibly be of broader interest, such as the ability of Greece to finance itself next month.

That particular elephant in the room, and perhaps – who knows? – a Brexit vote here in a couple of weeks will give investors rather more to chew on than the ECB’s plans for monetary policy over the next few months. Having said that, eurozone unemployment has stayed stuck above 10% despite what passes there for a robust rate of growth. (Mr Draghi certainly does have a point about structural reform.) There is no realistic prospect of monetary tightening for a long time: markets suggest 2020. The ECB watch point for markets will be rhetoric and planning over emergency measures. However effective they may or may not be in practice their announcement always carries the power to disappoint and while a second-order issue relative to European politics at the moment this remains a source of risk.

Over at the Bank of Japan the story is similar. The yen has strengthened by 11% this year which is a disaster for Japan’s economy. Abenomics, too, have been faltering for some time. Deflation is back. The central bank is torn over the issue of negative interest rates adopted earlier this year and whose effects, if there are to be any, have yet to be felt. At a public meeting this week Deputy Governor Nakaso signalled the BoJ would do more if needed – but this was possibly nothing more than an effort to talk the currency down.

The BoJ’s next meeting is next week. It has not attracted half so much of the market’s attention as the Fed or the ECB but as in Europe the watch point is the reaction to policy announcements. If the BoJ adopts more emergency measures unexpectedly that could give Tokyo a nice boost, especially if it led to a weaker yen. The interest here though is more domestic than global for now.

Over at Threadneedle Street there has been a period of calm – at least on the monetary front. (Mr Carney’s regular warnings about the dire consequences of a Brexit have been a feature of life at the Bank of England since the early spring.) Rates wise expectations are as low as they were during the panic in February and the futures market is not pricing for an increase in the base rate until the second half of 2018.

In terms of things to watch the Old Lady is at the more interesting end of the spectrum. Carney has decried negative rates as ushering in a “zero sum game” via currency wars but that was before the hideous spectre of Brexit loomed. The possibility of negative rates has been mooted by one of his MPC confreres and if the Bank is serious about its rhetoric a Brexit vote could see a major surprise in that direction. That would potentially be great news for gilts but probably not much else.

On the other hand the May Inflation Report, as usual, forecast that under present conditions CPI would bosh back up to 2% in time to meet the Bank’s commitment to that target on a two year horizon. We know about the fading of energy-driven deflation. We know that the UK economy is at or close to full employment. The industrial production number for May was the strongest in nearly four years and core CPI inflation, which bottomed at 0.8% over a year ago, has yet to fall below 1.2% in 2016. So we could find ourselves with something of an earlier hike than is currently priced in, and that again might surprise markets depending on the circumstances.

Despite the dominance of politics there is thus much to follow from the central bankers, and most of it would seem to present more of a threat to risk markets than an opportunity.

10/06/2016 at 3:51 pm


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