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The markets have a myopic focus on one thing: the UK referendum vote.
In the overnight session, the S&P 500 found buyers on open going on to test the 2100 area, but has been faded consistently through the day to finish 0.8% from the high. Aussie SPI futures came along for the ride and are now effectively unchanged from the cash market close, so we are expecting a flat open for the ASX 200. All the euphoria of yesterday has seemingly abated and we have hit the refresh button. We may need to take this week one day at a time; such is the nervousness around trading.
With regards to the S&P 500, I question whether the move lower in US stocks was simply a concern with holding risk for too long and traders happy to take even the smallest of profits. On the other hand, there is a genuine belief that if the UK referendum proves to be a market positive event, then being investing in European stocks (over US stocks) is clearly the way to be positioned. The US has outperformed in such a dramatic fashion, which we can see best in ratio analysis.
All eyes on further referendum polls
It really is all about European markets, be it fixed income, credit or equity. This is where we should be looking this week for inspiration. Naturally, the polls still play a big part and there are a few big ones tonight with the ORB (phone), YouGov (online), National Centre and IG’s Survation poll. For GBP/USD watchers, the Oddchecker probability of a ‘remain’ vote has risen to 79% (IG’s own referendum probability of remain has risen to 76%) and it’s interesting to see the startling correlation between these odds and GBP/USD.
The polls were not supposed to influence as much as they have, but we have seen a rampant positon adjustment overnight and an unwinding of ‘Brexit’ hedges. One-week GBP/USD implied volatility has fallen from 47% to 39%, the Italian and German ten-year bond yield spread has narrowed a huge 11 basis points and sub-investment grade credit default swaps index over European corporate credit collapsed by a massive 28 basis points – the biggest move since 11 March. This has driven a strong move higher in European banking sector and in turn, this should support the Australian banking sector today, as this should provide a positive influence on the funding markets.
I listed yesterday a number of contrarian indicators that one could extrapolate to suggest this Friday will not see the sort of crazy price action that happens in illiquid times. These included the European Commission President Donald Tusk warning that a UK vote to leave could ‘threaten Western political civilisation’ and much talk in social media of the new ‘Lehman’s’ moment. We are now also hearing that UK Chancellor George Osborne is not ruling out suspending trade on the LSE on Friday if things get out of hand. Personally, this would be a huge negative and would push traders to hedge their FTSE equity exposure through other equity or futures markets, which have which similar correlation. It’s pushing the problem onto another market. Do all exchanges then shut at once? It reminds me of the Russian experiment in 2008 when they closed their equity market to avoid pandemonium, only to open when we saw global markets having a strong rally.