Brexit fears abate, risk appetite increases

We’re heading into the business end of UK referendum and peak noise.

GBP
Source: Bloomberg

The ‘remain’ camp has polled well in a weekend Survation poll (for the Sunday Mail), with David Cameron finally showing some heart in the live BBC debate – at least according to some. Nigel Farage’s ‘Bursting point’ poster concerning the refugee crisis looks as though it has backfired with many seeing the horrific humanitarian side of the issue. The odds of the UK leaving the EU have fallen below 30% again, but there are at least five more polls to go and given the 130% increase in GBP/USD 1-week implied options volatility on Friday, this is still a market that is fragile and happy to turn on a dime. For now though, risk appetite has increased with a 1.3% increase in GBP/JPY this morning, S&P futures have rallied 0.6%, oil is up 0.7% and gold 0.9% lower. The ASX 200 is likely to test 5200 on open.

In terms of direct economics, a modest 2% of Australian exports go to the UK and 3% to Europe, so a decline in UK consumption would not be a terrible negative for Australia. In fact, an exit from the EU could see the UK forge greater trade relations with Australia and other Commonwealth nations. However, the offsetting mechanism would be a strong tightening of financial conditions, with sentiment likely to focus on the funding markets which would exude clear stress. Emerging markets with large USD liabilities would face huge headwinds, and one suspects Aussie banks would be savaged not just because of an unwinding of income structures (on higher volatility), but because wholesale funding markets would react negatively.

The fact that the European Commission President Donald Tusk has warned that a UK vote to leave could ‘threaten Western political civilisation’ has to be the biggest contrarian indicator of all time, along with comments from others that we are staring at ‘another Lehman moment’. A number of investment banks have written to institutional clients warning of thin liquidity on Friday that could exasperate moves which seems prudent, although the Swiss National Bank, Bank of Japan and Federal Reserve have all detailed that they will flood the market with liquidity should that situation arise.

For today though, it seems logical that we are staring at a lively open for the local market, with BHP’s ADR already up 3.5%. Volumes through the equity market will be key today, as this will detail whether any buying has genuine backbone or whether this is more a position adjustment. Keep an eye on the fixed income markets, because when you hear that global government bonds are annualising 23% year-to-date, which according to Bank of America is the highest in 30 years, it suggests we are close to bursting point.

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