Trader's thoughts - Brexit and the unfolding drama was the headline issue overnight

There were many swings in the story yesterday, but ultimately, the simple fact this morning is this: UK Prime Minister Theresa May’s Brexit deal has been voted down again.

Market data Source: Bloomberg

Financials drag on the ASX

The ASX 200 was legged in the final stages of trade yesterday. It was led by a sell-off in major financial stocks, after a media address made by Australian Treasurer, Josh Frydenberg, during which he announced the Liberal government would not pursue the eradication of trailing commissions for financial advisors and mortgage brokers, as prescribed by Kenneth Hayne QC in the final Banking Royal Commission report. It turned what was an otherwise solid day for the ASX 200 on its head. Naturally, given their substantial weighting in the index, a bad day for the banks more-often than not leads to a pull-back in the market. That notion certainly proved to yesterday and looks to prove true again this morning.

A good lead, but a weak start

Thus, at time of writing, SPI Futures are pointing a 7-point drop at the open. With half-an-hour left in Wall Street trade, it won’t be for a lack of a positive lead that this will be so. It’s been a reasonable day for US stocks, rallying just over 0.3 per cent, according to the S&P 500. Market participants, it would seem, have had hurled back at them, when it comes to the banks, the political risk to the industry, they’d thought, had disappeared following the final report handed down by the Royal Commission. This being the case, the simplest answer for the ASX’s likely sluggish start today is this returning shadow of regulatory uncertainty over the financial sector.

Banks back into the spotlight

Numerous specific explanations could be offered regarding the exact rationale for trader’s sell-off in financial-stocks. Many of them are politically-charged and filled with bias. For some inclined to one way of thinking, it might be because the Government’s new-position invites the Labor opposition to go harder on their “bank-bashing” (as it has become colloquially known) and raised the prospect of harsher regulations on the banks. The overarching explanation, no matter the specific reasoning, however, can be summed up in a cliché about markets: the only thing worse than bad news in markets, is uncertainty. Yesterday’s proclamations from the Government reintroduce uncertainty to the banking industry and create reason to avoid long positions in the banking stocks.

Some of the bullish stories

Hence, despite some reasons to climb further today, the ASX 200 may struggle to stay out of the red. It will come in the face of other macro-factors that ought to support stocks in Australia – and across the region. For one, industrial metals elegantly bounced from trendline support to sustain its recent run higher, which augurs well for the materials sector today. Oil is edging higher once more, so another day of gains for the energy sector could be in store. And a further play into health care and information technology stocks on Wall Street last night suggests an appetite for growth and risk in the market, pointing to positive conditions for highly weighted biotechnology firms on the ASX 200.

US CPI and global yields: Even more fundamentally, risk appetite was galvanized by a general fall in bond yields overnight. While still well within their broad range, US 10 Year Treasury yields fell 4 basis points to 2.60%, after US CPI numbers missed expectations. The headline core CPI figure printed a lukewarm 2.1% – effectively affirming, for now, that the US Fed is under very little pressure to hike interest rates. The knock-on effect was tangible throughout fixed-income and currency markets: 10 Year German Bunds clocked another multiyear low around at around 0.05% and the USD gave up ground, as it lost some of the yield advantage that has fuelled its recent rally.

A higher chance of a Fed cut

Inflation expectations for the US economy have been tempered after last night’s CPI miss. The US 2 Year Breakeven rate slipped below 1.90% – revealing a market that believes that inflation in the US will continue to languish below the Fed’s 2% “symmetrical” target. The dynamic has manifested in the implied probabilities US interest rate markets. A rate cut from the Fed is now considered a roughly 36% chance before the end of 2019. It’s taken market positioning to levels not witnessed since the start of January – that being a time, of course, when the market was still being shaped by the massive market correction experienced in the last quarter of 2018.

Brexit update

For everything else going on in markets, Brexit and the unfolding drama in that issue was the headline issue for traders overnight. There were many swings in the story yesterday, but ultimately, the simple fact this morning is this: UK Prime Minister Theresa May’s Brexit deal has been voted down again. It was by a smaller a margin this time – a 149 vote deficit. But nevertheless, the defeat was resounding, and ensures that the toxic effect of Brexit on markets lingers. The Sterling has whipped around in a 2.4% range in the last 48 hours. Similar volatility is expected as the House votes tomorrow morning on whether to exit the EU with “no deal” at all.


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