Global Daily – Does anyone have a plan?

by: Nick Kounis , Georgette Boele , Roy Teo , Aline Schuiling , Kim Liu

Brexit aftermath – When watching a ship heading for an iceberg, the last thing one wants to see is that there is no captain at the helm. This is the way it has felt following the UK’s vote to leave the European Union. The idea that policymakers had a clear plan of action and would lead the process in a relatively smooth manner seemed to be spectacularly dispelled from all sides as events unfolded. There is a leadership vacuum, with UK Prime Minister Cameron having effectively stepped down, and the Leader of the Opposition Corbyn facing a coup from within his own ranks following mass resignations from his shadow cabinet. The pro-Brexit Conservative leadership candidate Johnson does not appear to have a clear view of when to invoke Article 50 or what specific arrangements the UK should seek following its exit. Meanwhile, leading EU governments are urging the UK not to wait too long to invoke the clause and are refusing to enter informal negotiations with the UK before then. Adding to the sense of chaos, the leader of the Scottish National Party, Sturgeon, wants to keep the country in the EU, and is signalling that a new referendum to trigger independence from the UK may well be necessary. Overnight rating agencies S&P and Fitch have cut UK rating to AA with a negative outlook. (Nick Kounis)


Global-Daily-Insight-28-June-2016-1.pdf (168 KB)


Global Markets – Markets continued to adjust to the reality of Brexit on Monday. Investor risk appetite continued to deteriorate, with risky assets seeing a rout, while there was strong demand for safe haven assets. Equity markets fell significantly further in the US as well as Europe, while German Bund yields and US Treasury yields headed lower. A number of factors explain these moves. First of all, investors are likely downgrading their views of the economic outlook. This means lower earnings, less inflation and more accommodative monetary policy. Indeed, we are also in the process of reducing our macro and interest rate forecasts, as well as reviewing our FX calls, and will be publishing our new base case as well as an adverse scenario later this week. A second factor is uncertainty. There are more questions than answers when trying to assess exactly how the situation will unfold, and the risks seem skewed to the downside. So markets also appear to be building in risk premiums. This is especially the case when the risk is political and hence difficult to price, and policymakers are not providing clear guidance on the way forward. In the coming days, statements from policymakers will be crucial for market direction, but it is difficult to imagine that the process going forward will be anything other than messy. (Nick Kounis)


FX – The Brexit fallout is particularly visible in currency markets. Sterling was hit hard again; it dropped to a new low (below 1.32) on Monday versus the US dollar and the euro. EUR/GBP broke above 0.83. This is because UK political uncertainty and the negative impact from Brexit on the economy outweighed fear of contagion to the eurozone. We expect further weakness in sterling this year. GBP/USD even sold off to levels not seen since 1985. Paradoxically, movements in the options market show less panic. For example, volatility has come down, while demand to hedge downside in sterling has eased somewhat. For the FX options market, the largest panic was just before the referendum, however demand for downside protection is also further out. Gold prices gained to above USD 1,330 per ounce again. We expect prices to clear the Friday peak just below USD 1,360 in the coming days and weeks. The US dollar also rallied, while the euro was weak. Fears of a possible contagion from Brexit weighed on the euro. Meanwhile, gains in the yen were limited due to fears of intervention and the possibility of an unscheduled monetary policy response from the BoJ. (Georgette Boele & Roy Teo)


Spanish elections – Political risk is not only a UK issue, but can be seen in one shape or another in virtually every European country. Spain’s second General Election in six months did not end the fragmentation of the political landscape in the country, though markets were relieved that the anti-establishment, left-wing Podemos party did not make the gains predicted in the polls. Mariano Rajoy’s centre-right Partido Popular won 11 seats and extended its lead over the other parties, but forming a stable coalition remains problematic, implying that new elections remain a realistic possibility. Meanwhile, the public finances have been going in the wrong direction despite strong economic growth. Spain could be one of the first countries that will be fined by the European Commission for overshooting its deficit target. Despite the compression in Spanish government bond yield spreads over Germany seen following the outcome, we expect that the political risk premium in Spanish government bonds is likely to persist. Furthermore, Spanish bonds will remain vulnerable during bouts of risk aversion. For more on this topic, please see our research note Euro Rates Watch – Spain’s political stalemate continues (Aline Schuiling & Kim Liu)