The effects of the British decision to leave the EU, or more correctly, the complete misreading of that risk by financial markets, will continue to reverberate through forex, stock, bond, credit, and commodity markets in the weeks ahead.
While tensions are high and fears of knock-on effects for the global economy and markets palpable, Friday’s trade could have been much worse and should be viewed in the context of the recent rally in stocks and other markets, chief investment officer at UBS Wealth Management Mark Haefele wrote in a note Friday.
It is important to remember that although the equity market moves have been significant, they come in the context of a sharp rally in recent weeks, as markets had moved to largely price out the risk of Brexit. Betting markets had moved from pricing the risk of Brexit at around 40% last Friday to as little as 15% yesterday. While expectations clearly needed to readjust, markets are now, in general, back to levels of last week, and above the lows of last month. As such, today’s moves should not be considered a major change in momentum at this stage. Even the British pound is overall down by only 2% in the past 10 days.
That doesn’t mean that there are no risks for markets — uncertainty itself is poison more often than not for the psyche of traders and investors. But there is no reason to think this decision is a rerun of the collapse of the Lehman Brothers or its mini-precursor, the demise of hedge fund Long Term Capital Management (LTCM).
Certainly, most forecasters expect the UK and European economies to slow. But the fallout to the wider world while the Bank of England, ECB, Fed and other central banks are on standby to provide emergency liquidity and lower rates should forestall contagion for now.
Goldman Sachs says central banks will maintain market function Andrew Benito, senior European economist at Goldman Sachs wrote in a note Friday in the aftermath of Britain’s decision that:
We had expected the BoE to stand behind markets and to maintain market functioning today. Mr Carney’s statement this morning focused on that message. Our view was that Governor Carney would activate swap lines agreed with other major central banks, including the Fed and ECB. In his statement, Governor Carney indicated that the BoE can provide substantial liquidity in foreign currency “if needed“. These announcements are intended to mitigate foreign exchange volatility and support bank funding, including foreign currency funding. Many of these facilities were put in place in response to earlier market tensions.
As part of these measures, he said that Goldman expects “further policy easing to be announced by the BoE at its July 14 MPC meeting, focused on credit easing measures. We expect a programme of asset purchases to be announced focused on (non-bank) corporate debt”.
Goldman also believes the BoE will backstop bank funding costs — a crucial circuit breaker to avoid a LTCM or Lehman rerun. Benito said “should bank funding costs rise, as seems quite likely, we would also expect the BoE and HM Treasury to announce an extension of the Funding for Lending Scheme”.
The Aussie dollar might surprise everyone and stay strong. There were a number of remarkable moves on Friday. The range the Pound traded on the day of around 1800 points was unprecedented, the 30% drop before recovery in UK bank stock prices, the 8% collapse in the Nikkei and the all-time low close in the number of 10-year bond rates around the globe — including the Australian 10-year government bond rate which finished the week at 1.985%.
Another remarkable performance was the recovery in the Australian dollar which ended the week at 0.7465. That was midway between the low of the day at 0.7302 and Friday’s high around 0.7640. But given the acute level of risk aversion that gripped traders and global markets, a weekly close at such a level is a strong signal that in a world of global uncertainty, Australia’s economic growth, AAA status and interest rate structure may make the Australian dollar a safe harbour in this global storm.
Aussie dollar strength in the current environment would surprise many. But it’s happened before.
Australian Calendar — (courtesy NAB Economics, our emphasis)
All eyes will be offshore this week given it is a very quiet data week with second-tier data only. After Tuesday’s Weekly Consumer Confidence which this week hit a 2-year high, there’s ABS Job Vacancies and RBA Credit Thursday, then CoreLogic RP Data house prices on Friday.
How will the RBA view the British EU result
While a Brexit would not have been many folks’ base case, all central banks would have stress tested their economy and banking system for the possibility that Britain did vote that way. So like the BoE, the ECB, the Fed and the RBA will have contingency plans for the possible fallout from the vote.
The NAB says that if “the global growth outlook slows in coming months the RBA would revise down its growth forecasts and the probability of further rate cuts would increase”. Indeed depending on how bad the market’s reaction is – stocks and credit spreads in particular – over the week and a half ahead the NAB says “the Bank might consider a stabilising rate cut as early as July, as it did during the Global Financial Crisis”. But “this seems unlikely,” the NAB says.
International Calendar (also courtesy NAB Market Economics)
Global : Fallout from Brexit and EU leaders meeting on Tuesday/Wednesday to be a big focus for traders.
US: Durable Goods Orders and UoM Consumer Sentiment tonight. Highlights next week include Wednesday’s Personal Spending/PCE Deflators report and Friday’s ISM Manufacturing where focus will be on the employment sub-index. Yellen also speaks Wednesday. Thursday’s speech from Fed President Bullard might also be of interest. Other data includes the Goods trade balance, revised Q1 GDP, Case-Shiller house prices, Conf Board Consumer Confidence and the Chicago PMI.
China: The main focus will be Friday’s official PMIs and Caixin Manufacturing PMI. PBoC Governor Zhou speaks at a ECB forum in Portugal on Monday evening.
Japan: Retail Trade on Wednesday, industrial production on Thursday, then super Friday with jobless rate, household spending, CPI, and BOJ Tankan survey all due.
Euro: EU leaders meet Tuesday and Wednesday with Brexit front and centre. Datawise, German Ifo tonight, then Eurozone Business Climate Indicator on Wednesday, CPI Thursday, and unemployment Friday.
UK: Brexit fallout and then Thursday’s revised Q1 GDP and the Markit Manufacturing PMI on Friday.
Canada: April GDP on Thursday, along with Industrial Product and Raw Materials Prices.
NZ: Statistics NZ to release Labour Force Survey revisions Wednesday, followed Thursday by the ANZ Business Survey. Other data includes Monday’s merchandise trade and New Residential Lending reports, then Thursday’s Credit Aggregates and Building Consents.