It’s been all about the GBP again today, with the aftershocks of Fridays shock vote getting the extra kicker of more protracted political uncertainty in the UK, with the market seeing little in the way of planning and the confusion reigns around the enactment of Article 50, with the Labour party also seemingly imploding around Jeremy Corbyn. It is not just the currency markets that are moving though, FTSE futures are trading a further 3.2% lower and our calls for Europe once again looking very precarious.
As things stand IG are calling the FTSE at 5967, DAX 9357 -200 and CAC 4017 -99. Importantly, there has been better buying and out calls have certainly been much lower today.
US treasuries have been well bid today (the U.S. 10-Year is trading 5bp lower at 1.50%), while gold has also moved higher and eyeing further move into $1350, which was a level where traders were happy to sell on Friday.
The question that is seemingly getting more traction 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 latter question would likely come from another coordinated 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 RBA by the August meeting and we are even seeing a 14% chance of a cut from the Fed by September. Clearly the prospect of additional easing from the BoJ 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 Janet Yellen at tonight’s ECB Forum, but also St Louis Fed president James Bullard who speaks on Thursday (or Friday 03:30 AEST) in London. BoE head 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 the one that really interests me as this would echo moves from the ECB in 2011, although Yellen at al would argue the risks are predominantly external. There has been some talk of 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 today in Australia suggest most in the market feel we are seeing a short-term shock than something more protracted and sinister.
As I have said for most of the year doing the opposite of what feels right has been the best trade, but it still seems logical that the GBP still has downside. 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 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, although Chancellor George Osborne speaks shortly today at 15:00 AEST which could give GBP a boost merely on any clarity, although this would represent a selling opportunity.
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. Expect more selling on open today given our current equity calls.
- USD inflows have ramped up, with the US Dollar Index having its best gain since 2008 on Friday. The USD has gained a further 0.8% today and one has to question what this means for US inflation and of course emerging markets who hold significant USD liabilities.
- Watch iShares MSCI Emerging Markets (NYSE:EEM) 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 wont 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 wont fill anyone with confidence. Certainly the S&P 500 is looking quite precarious, having broken and closing through key support. Short positions are clearly looking more attractive.
