• Weekly Bulletin: It’s all about the referendum

    Week Ahead: Monday 20th – Friday 24th June

    Economic Outlook

    Last week’s violent market moves proved just how febrile sentiment currently is. Investors are struggling to deal with uncertainty over the robustness of global economic growth, the actions of central bankers and the prospect of political upheaval in Europe.

    This Thursday we have the UK referendum on EU membership. This will continue to overshadow everything as investors continually recalculate the odds on a Brexit. This is a pivotal event, with an asymmetric risk for investors over the short-to-medium term. A vote to remain appears to be a vote for the status quo, whatever that may eventually turn out to be. This should see risk assets rally and hedges unwind. Sterling should bounce and equity markets get a lift – at least in the short term, while precious metals look likely to pull back from recent highs. But a vote to leave will have more serious market consequences. We may end up with a more dynamic economy with independent trade deals with countries that have real growth potential. But we have little idea what the relationship between the UK and EU may look like in the future, or how long that will take to achieve.

    For most of last week we saw investors rush to dump risk assets as a succession of polls showed growing momentum for the “Leave” campaign. Yet one terrible event showed the degree of investor feverishness more than any other. The shocking and senseless murder of Labour MP and “Remain” campaigner Jo Cox led to dramatic market moves globally. Sterling rallied along with equities as investors (or trading algorithms) calculated that this tragic event increased the chances of the UK voting to stay within the EU. This was despite few details being known about the motives or mental state of her killer. I’m afraid we have to expect further volatility this week too.

    Whatever the eventual result, markets will have to reset. It’s accepted by both sides that a vote to leave will impact on the economies of the UK and those of EU member states. But whereas the Remain campaign are saying that these will be devastating and long-lasting, the Brexiteers claim that any disruption will be short-lived and a price well worth paying.

    The bottom-line is that the referendum vote is just too close to call. It doesn’t matter what the polls or the bookies are saying, there are too many undecided voters to get an accurate fix on the result, and voter turnout will have a huge influence on the result.

    Turning to central bank monetary policy, it feels as if we may be approaching some kind of endgame. For decades now central banks (particularly the Fed) have exerted a growing influence on financial markets. This has become particularly acute since the financial crisis which reached its nadir in early 2009. Not only were interest rates cut to historically low levels, but the world’s major central banks drove wave after wave of monetary stimulus into the financial system in an effort to kick-start growth and fend off the deflationary forces of a busted debt bubble. These rate cuts and injections of stimulus were supposed to be temporary measures. Yet seven years on, despite repeated attempts to turn the global economy round, all they’ve done is further enrich the wealthy and hold off the day of financial reckoning.

    Last week there were signs that the major central banks are getting ready to throw in the towel. The Bank of Japan (BOJ) held off from further monetary stimulus, having now delayed easing since it unexpectedly adopted a negative interest rate policy back in January. Unfortunately, the yen strengthened rather than weakened following this move. It now looks as if the BOJ is petrified of easing monetary policy further in case the yen continues to rally. That would mean Japanese monetary policy is a busted flush.

    Also last week the US Federal Reserve released its latest rate statement and updated its Summary of Economic Projections. These were viewed as being far more dovish than expected. GDP forecasts were lowered slightly while the central bank noted that the market’s inflation expectations had declined. But most importantly the number of Fed participants anticipating just one rate hike for the rest of this year went up to six from one in March. This was significant, even if the median call remains at two for 2016.

    One analyst summed up the view of many saying this is as dovish as the Fed could be without actually cutting rates. In fact, the chances of a July hike have evaporated while the possibility of a cut has risen. On top of this, Janet Yellen’s subsequent press conference was viewed as a mess. As one commentator put it, the Fed tried to lead the markets, now the markets are leading the Fed.

    The bottom line is that the outlook for US economic growth is so poor that the Fed probably can’t risk a rate hike this year, let alone next month. This was not the message the Fed wanted to send out. But that’s what the market heard. This suggests we’re in for a rocky summer, Brexit or no Brexit.

    This week’s major economic releases include:

    EUR German PPI, German Buba Monthly Report; CAD Wholesale Sales; AUD CB Leading Index


    AUD RBA Assist Gov Debelle Speaks, Monetary Policy Meeting Minutes, HPI; JPY Monetary Policy Meeting Minutes, All Industries Activity; CHF Trade Balance; GBP Public Sector Net Borrowing, CBI Industrial Order Expectations; EUR      German Constitutional Court Ruling, German ZEW Economic Sentiment, ZEW Economic Sentiment; USD Fed Chair Yellen Testifies


    CHF ZEW Economic Expectations; CAD Retail Sales, SNB Quarterly Bulletin; EUR Consumer Confidence; USD      Fed Chair Yellen Testifies, Existing Home Sales, Crude Oil Inventories


    GBP UK Referendum, GfK Consumer Confidence; JPY Flash Manufacturing PMI; EUR French, German and Euro zone Flash Manufacturing and Services PMIs, Euro zone Long Term Refinancing Option; USD Unemployment Claims, Flash Manufacturing PMI, New Home Sales


    JPY BOJ Summary of Opinions; EUR German Import Prices, German Ifo Business Climate, Italian Retail Sales; GBP BBA Mortgage Approvals; USD Durable Goods Orders, Consumer Sentiment, Inflation Expectations

    Equities Outlook

    The UK referendum is overshadowing share prices along with everything else. As far as the outcome affects equities, it’s generally accepted that a vote to stay will see stock markets rally, while a vote to leave will result in a sharp sell-off. This seems reasonable, if only in the short-term. But there will be individual winners and losers and ultimately the overall effect on the FTSE100 could be limited due to its constituents having a heavy international exposure. The share prices of big multinationals that derive a significant proportion of their revenues and earnings from countries outside the EU are likely to benefit from a leave vote. Quite simply, money will flow from stocks with direct exposure to Europe to those more internationally facing. Consequently, pharmaceuticals (such as AstraZeneca, GlaxoSmithKline and Shire), oil majors and miners are likely to benefit as could companies with low exposure to the EU such as Centrica and Prudential. But airlines and tour operators may suffer selling first with questions asked later. Those at risk include EasyJet and Carnival. In addition, companies with a purely domestic focus are also likely to sell off. This is because it’s widely thought that UK economic activity will slow on the back of a vote to leave. This list would include housebuilders, property companies and domestic banks such as Lloyds.

    Meanwhile, European stocks have been under pressure for over a year now. In contrast to the major US indices which are trading back close to all-time highs (despite last week’s sell-off), the euro-Stoxx 600 index (the main barometer of European stock market health) has repeatedly failed to bounce back convincingly following last August’s China-catalysed sell-off and a pull-back which ran from early December to mid-February this year. European stocks should get a lift if the UK votes to stay in the European Union. However, this may not last for long. Technically the chart doesn’t look particularly encouraging. The broad index has repeatedly failed to break back above its 200-day moving average.

    Chart of the STOXX Europe 600 Index with a 200-day exponential moving average, courtesy of www.stoxx.com

    Commodity/ FX Outlook


    Earlier this month both Brent and WTI broke “convincingly” above $50 per barrel. $50 is more a psychological level than a technical one, particularly as far as Brent is concerned. Nevertheless, the price was acting as resistance. Just over a week ago Brent and WTI appeared to be consolidating above here with the prospect of further gains to come. For one thing, a number of analysts (who I talked about in other reports) had pointed out that US shale oil producers would need to see an oil price on its way to $60 or even $70 before they would resume drilling. This was due to high levels of indebtedness which effectively cut them off from capital markets. This meant they would have to finance fresh production from their own cash flow. While some producers would be able to do this at $50 per barrel, the majority would not. Cash flow is a particular problem for US shale producers due to the sharp depletion rates typical in this type of oil production. That is, output drops off much quicker for a new well in shale production than conventional drilling. This being the case, it looked unlikely that US oil production (which has dropped off sharply over the past year) was set to recover much at current prices. This suggested that oil prices, other things being equal, would not be depressed by a surge in US production.

    Yet crude fell sharply last week. Profit-taking played a part. After all, both Brent and WTI have nearly doubled in price since the beginning of this year. At the same time there’s been a general loss of risk appetite as we approach the UK referendum. There are also concerns over the outlook for global growth. These fears have been exacerbated by the continued slide in bond yields. Undoubtedly, there’s been a flight to safety ahead of this week’s vote. But investors are also fearful of the prospect of a deflationary/low growth economic environment for years to come. This view was supported following the US Fed’s Summary of Economic Projections last week. If correct then crude demand growth should begin to slow.


    After experiencing a torrid sell-off throughout May, gold and silver have continued to surge higher this month. Silver is still below its best levels from earlier this year. At the very beginning of May it briefly broke above $18 per ounce before beginning a descent which took it back below $16 a few weeks later. However, by the end of last week it looked as if silver was on its way to take out this year’s high despite a sharp sell-off following the murder of Labour MP and “Remain” campaigner Jo Cox.

    Last week saw gold hit an intra-day high of $1,315 - its best level since August 2014. It too pulled back after Jo Cox’s killing led to speculation that the tragic event in some way boosted the “Remain” campaign. However, it seems more likely that the overall market reaction (which happened in FX, bonds and equities as well) was a symptom of investor skittishness ahead of the referendum, and no doubt a result of headline-driven algorithmic trading as well.

    Both precious metals made gains following a clutch of central bank meetings last week. On Wednesday the US Federal Reserve released its latest statement and quarterly summary of economic projections. The Fed signalled a more dovish stance which weighed on the dollar and lifted gold and silver. Many analysts now believe that the Fed probably can’t risk a rate hike this year, let alone next month. The prospect of lower interest rates for longer is positive for the two precious metals as both are attractive assets to hold in a low interest rate world. This is because the lost-opportunity cost of owning gold or silver is reduced when other assets yield nothing – or have negative yields as is currently the case with $10-11 trillion of government debt worldwide. The buying continued after the BOJ held back from announcing further stimulus. This caused the yen to soar as investors went into “risk-off” mode. Gold and silver continue to get a boost from safe-haven buying ahead of this week’s UK referendum on EU membership.


    FX markets were particularly volatile last week and that volatility looks set to continue. All the major central bank meetings are now behind us and despite this being a busy week for data releases the focus will be on Thursday’s UK referendum on EU membership.

    Despite the volatility, it was noteworthy that many of the major currency pairs ended little-changed on the week. Naturally there were some big trading ranges particularly with pairs containing sterling. Yet it is interesting that cable held above 1.4000. With the referendum so close and the “Leave” vote continuing to lead “Remain” in the polls, the GBPUSD is still trading above the lows hit back in February this year. This suggests to me that the FX market still believes that the UK will vote to stay in. After all, everybody and his dog (and that includes Bank of England (BOE) Governor Mark Carney) has warned that sterling will plummet on a Brexit vote. Cable hit its lowest point in over two months last week following the BOE’s decision to keep its Bank Rate unchanged at 0.5% where it's been for over seven years. The Bank also issued the warning that a vote to leave the EU would hurt the global economy and the referendum was not only the biggest immediate risk to UK markets, but global ones too.

    The dollar fell in the immediate aftermath of the US Federal Reserve’s June meeting. The central bank kept its headline Fed Funds rate unchanged in a range of 0.50% and below. It also released its latest rate statement and updated its Summary of Economic Projections. The Fed was viewed as being more dovish than expected. The central bank lowered its GDP forecasts slightly while noting that the market’s inflation expectations had declined. But most importantly Fed participants anticipating just one rate hike for the rest of this year went up to six from one in March. This was significant, even if the median call remains at two for 2016.

    However, the biggest takeaway from the Fed meeting was how little credibility the central bank now has. Numerous commentators appeared to say that the Fed appears to have lost the plot and is now floundering around from one data release to another. This, together with a BOJ meeting which suggested paralysis amongst Japanese central bankers, and of course Brexit fears saw the dollar fly higher the following day as investors rushed into safe havens. This was when correlations broke down as gold and silver made strong gains along with the dollar – something we rarely see.

    The shocking murder of Labour MP and prominent Remain campaigner Jo Cox led to a sharp rally in both sterling and the euro. This was all part of a risk-off move as there was speculation that Ms Cox’s killing would disrupt the “Leave” campaign’s upside momentum. Both sides agreed to halt their campaigns temporarily as a mark of respect for Jo Cox and her family.

    The Japanese yen was another big mover last week. It soared higher following the news that the Bank of Japan (BOJ) was leaving its monetary policy unchanged while lowering its inflation forecast. The USDJPY slumped below 104.00 as there was some surprise that the central bank failed to hint that further monetary stimulus was being considered. The nearer the USDJPY gets to 100.00 the greater the speculation that Japanese policymakers will intervene to halt the strengthening currency. This is unsettling markets generally as it suggests a policy misstep from the BOJ. The yen is another currency that benefits when investors go into “risk off” mode.

    This is set to be a rocky week in FX. Volatility, together with the likelihood that liquidity dries up ahead of the referendum, will mean big swings and price gaps. But this won’t be isolated to sterling and sterling-related financial instruments as so many markets are correlated these days. Yet it’s quite possible that many of these correlations will break down on the lead-up to and then directly after the referendum result.

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