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The British pound is under pressure again, as the aftershocks of the ‘Brexit’ vote turn into more protracted political uncertainty in the UK. The market apparently sees little in the way of planning, and confusion reigns around the enactment of Article 50. On top of that, the Labour party is also seemingly imploding around Jeremy Corbyn. It’s not just the pound – the FTSE 100 is down a further 1.7%, with banks and housebuilders again taking a beating.
US treasuries have been well bid, with the US 10-year trading five basis points lower at 1.50%, while gold has also moved higher and is eyeing a further move into $1350, which was a level where traders were happy to sell on Friday.
The key question is whether the UK referendum vote represents a shock to markets or a potential genuine crisis. The focus then has to be on what would be the circuit breaker. The answer for the latter question would likely come from another co-ordinated central bank response, with shared liquidity through swap lines and easing of monetary policy, with increased forward guidance.
This is already being priced in, with the swaps markets pricing a 65% chance of easing from the Bank of England this year, a 60% chance of easing from the Reserve Bank of Australia by the August meeting and we are even seeing a 14% chance of a cut from the US Federal Reserve by September.
Clearly the prospect of additional easing from the Bank of Japan at the 29 July meeting should now be consensus, although this won’t change the actual inflation outlook in Japan. There has also been some reporting of additional fiscal support in Japan, which is one of the more bullish factors supporting the Nikkei 225 today.
The fact the Fed Funds Future is pricing a chance of easing in the US could well be an overshoot and would represent a huge blow to the Fed. This week traders would be wise to listen to commentary not just from Fed chair Janet Yellen at tonight’s European Central Bank Forum, but also St Louis Fed president James Bullard who speaks on Thursday in London. BoE Governor Mark Carney is also due to speak at the ECB Forum, but there is speculation he could pull out.
The idea of easing from the Fed is most interesting as this would echo moves from the ECB in 2011, although Ms Yellen et al would argue the risks are predominantly external. There has been some talk of a fourth round of quantitative easing, dubbed QE4, from market players, but it’s tough to feel a fresh round of asset purchases will actually have any benefit at all given current fixed income pricing.
Let’s see what the response is, but the risks are building and the fact we seeing buying in select stocks in the UK and elsewhere suggest most in the market feel we are seeing a short-term shock rather than something more protracted and sinister.
It still seems logical the GBP will fall further. UK politics is a mess and there is so much confusion as to when and even if Article 50 is triggered, formally starting the process of a divorce from Europe. UK growth is likely to be closer to zero, if not in recession in 2017 and there is speculation of another round of QE. Add in the systematic trend of following funds now happy to sell and a general lack of buyers and Fridays intra-day low of $1.3228 seems quite achievable in the short-term.
It’s not just UK politics and the idea of how this may manifest into a broader European issue, but there are other macro thematics which need careful monitoring:
- European banks and overall concerns about solvency are back in the cross hairs, with credit default swaps blowing out on Friday
- Dollar inflows have ramped up, with the USD index having its best gain since 2008 on Friday. The USD has gained a further 0.8% on Monday and one has to question what this means for US inflation and of course emerging markets who hold significant USD liabilities
- Watch EEM (iShares Emerging Market ETF) as this ETF fell 6.1% on Friday and could give an indication of sentiment towards emerging markets
- China lifted the USD/CNY midpoint to 6.6375 (+599 pips) today to the highest level since December 2010. While traders aren’t necessarily talking about China capital outflows (as we did in January), this will undoubtedly be a risk. CNY is now trading at the strongest level relative to the EUR since March and again this is a huge headwind for markets like the DAX
- These issues were huge concerns in January and February and need close monitoring. So while the UK referendum won’t in itself cause a crisis, it has certainly unearthed a number of issues that could result in something concerning
One then just needs to look at the technical set-up in various equity markets and these won’t fill anyone with confidence. Certainly the S&P 500 is looking quite precarious, having broken and closed through key support. Short positions are clearly looking more attractive.