On the contrary, the risk appetite has recovered strongly early in the week. This is disconcerting for me. It seemingly dismissed the gravity of the referendum outcome.
On the surface, the financial market reaction is undeniably sanguine despite overwhelming uncertainty relating to the road ahead for the UK. The Nikkei posted its first weekly gain (27 June – 1 July) of +4.8%, snapping a four-week losing streak. The index slumped 11% for most of June, giving up almost 1900 points.
However, the Nikkei 225 still posted the worst monthly loss (-9.7%) since May 2012 (-10.3%), when the Eurozone problems were at its height with a Grexit and a Spanish banking crisis looming. The Japanese yen was also incredibly strong at that time, trading below 80 against the dollar, and close to the all-time high of 75.82.
The MSCI all-country index also rebounded intensely. In UK, the FTSE 100 seemed to shrug off the Brexit vote, more than recouping its losses, surging to a 10-month high. However, if you look at the performance in terms of USD, it’s not so remarkable. FTSE 100 (USD terms) recouped slightly more than half of the 16.4% losses in a two-day period from 24-27 June.
There is a couple of theories for the sharp bounce. First, the narrowing universe for suitable investments that provide an acceptable return, in a low or negative interest rate environment. More and more sovereign bond are slipping into negative yield territory. Furthermore, the Brexit vote pushed sovereign debt yields lower. Commodities also do not provide a fantastic yield given sluggish global growth prospects. So investors have little choice but plough their capital back into equities.
Second, the markets are expecting a coordinated central bank response to soothe the expectant market volatility and damage to global economies. The Bank of England (BoE) was one of the first to say that they are looking at more easing measures over the summer. Governor Carney said that the BoE will announce its initial assessment at its next policy meeting on 14 Jul and a full assessment on 4 Aug. GBP remained heavy following the comments. In addition, Bloomberg reported that the ECB is considering easing rules for bond purchases as the pool of eligible securities has shrank due to the recent flight to safety.
I am sceptical about the sustainability of the risk rally given the enormous headwinds on the horizon, alongside the political wrangling in the UK, which will fuel the lifespan of uncertainty. Indeed, BoE Carney also believed that uncertainty will be around for a while. Risk appetite will continue to be susceptible to swift change in sentiments arising from news headlines. In the coming week, we would have to watch out for several things, apart from developments out from the UK.
Plenty of events to keep things interesting
We will be looking at how the ruling Conservative Party narrows its slate of candidates for the premiership in the first round next Tuesday, followed by a second round on Thursday, 7 July. Home Secretary Theresa May and Justice Secretary Michael Gove are the favourites.
US will be shut on Monday to commemorate its declaration of independence. Stock and bond markets will be closed.
On Tuesday, the BoE will release the semi-annual financial stability report, where Governor Carney will hold a press conference. The focus will no doubt be on Brexit. The Reserve Bank of Australia decides on monetary policy on Tuesday.
Staying on the central banks, the Federal Reserve will release the minutes from 14-15 June FOMC on Wednesday. Bank of Japan (BoJ) governor Kuroda will be speaking at the quarterly meeting of the central bank’s branch managers on Thursday. There will be a NATO summit in Warsaw, where participants include US President Obama, German Chancellor Merkel, UK PM Cameron and Canadian PM Trudeau.
On the data front, the early part of a new month always brings about the widely-watched US non-farm payrolls, where expectations are for an addition of 180,000 jobs in June. June’s data is especially important after the shocking job growth in May. 35,000 striking workers from Verizon has returned to work. Other noteworthy US data includes ISM manufacturing numbers, construction spending, factory orders and durable goods orders.
In Asia, China will see a heavy week, where inflation, FX reserves and Caixin services PMI will be published. Aggregate credit data may also be released. Singapore will report its official and private June PMI surveys, while advance Q2 GDP figures may be due in the week.