Month End Demand Trumps Brexit Woes

Thursday June 30: Five things the markets are talking about

Both month-end and quarter-end portfolio rebalancing demands are expected to temporarily gloss over some of the ills that last week’s shock Brexit vote would bring to capital markets.

Global equities have caught a bid into month end, sovereign yields have backed upped a tad, commodity prices are making an effort to rally, while the go to safe haven currency of choice, the yen, is trying desperately to take a couple of sessions off with some help from the Bank of Japan (BoJ).

Whether its economic, political, or cultural, markets are still trying to grasp the implications of Brexit. Its not easy as none of the interested parties seems to have come to the table with a predefined airtight exit strategy or a vision. But no matter what, Euro financial markets will never be the same again, and that is the new course that investors need to adjust for.

1. Is the pounds ‘relief rally’ sustainable?

To many, it’s not a surprise to see a bounce in the pound from its historic 31-year low recorded (£1.3224) after the Brexit vote Friday. It’s not the rally, but how high the current bounce will be that sterling ‘bulls’ are most concerned about.

Sterling outright trades up +0.2% at £1.3483, still performing relatively well as investors continue to take profit on hefty falls on Friday and Monday. Many believe that June month-end interest is potentially disguising some of the ills of Her Majesty’s currency. It’s difficult to find an outright sterling bull, and in a scenario like this, the top that that the bears are hoping to pick never materializes.

Perhaps the warning signs are already there as the pound remains below yesterday’s peak above of £1.3500? The EUR has dipped -0.1% to €1.1111 and is considered to be in headlights and waiting to play “falling” catch up with the pound. Brexit is not a Lehman’s story part two, its not a situation that will implode in the coming week’s it will be a long draw out affair that will have many instalments.

The markets reluctance to take on risk is being reflected in falls of -0.2% to -0.3% in the riskier Aussie and Kiwi dollars overnight, while the safe haven yen has found some takers, with USD/JPY down +0.2% and EUR/JPY down +0.3%.

2. Euro indices stabilize

European stock indices have opened lower, currently trading mixed across the board, as markets stabilize after a two-day rally following the sharp sell-off post-Brexit.

U.S futures point to a flat open for the S&P 500 this morning, while the Stoxx Europe 600 has inched down -0.1%. Both indexes yesterday posted their largest two-day gain since February.

It’s no surprise to see Euro banking stocks trading notably lower after Deutsche Banks and Santander’s U.S units both failed the Fed’s annual stress tests. The IMF yesterday also named Deutsche Bank as the riskiest financial institution in the world as the potential to be the source of external shocks to the financial system.

Commodity and mining stocks in the FTSE 100 trading higher on the back of rising oil prices with front month Brent breaking the psychological $50 handle again.

Indices: Stoxx50 flat at 2,832, FTSE -0.2% at 6,348, DAX -0.1% at 9,599, CAC-40 +0.1% at 4,199, IBEX-35 -0.6% at 8,059, FTSE MIB -1.2% at 15,758, SMI -0.1% at 7,971, S&P 500 Futures flat

3. U.S Treasury rallies show no sign of stopping

U.S treasuries continue to trade like a ‘hot’ commodity, from short to long debt product. By the time fixed income dealers are able to plot their yield curve record in their spreadsheets foreign demand for positive yield makes a mess of it.

U.S. debt is currently overseeing its strongest rally in six-years and still many participants believe it’s not time to bet against Treasuries. The yield on U.S 10’s remains atop of its record closing low yield (July 2012 +1.404%) at +1.477%.

In a year that started off with a Fed tightening bias, U.S 10’s are falling even further away from last December’s year-end close of +2.273%.

A sluggish global economy, the Fed’s hesitance to raise short-term interest rates and expansive monetary stimulus overseas (NIRP) continues to support the record demand for U.S debt this year.

Where to next for yields? Money markets (the short sighted on the curve) will looks to next week’s FOMC minutes and Friday’s non-farm payroll (NFP) for guidance.

4. Fed’s favorite inflation indicator remains stuck

One of the Fed’s favourite inflation tickers, Wednesday’s May Personal consumption expenditures (PCE) print showed no growth in annualized inflation. It remains at +1.6%, well below the Fed’s target of +2%.

The headline inflation was up +0.9% from +1.1% in April, while the core-rate was unchanged at +1.6% y/y. Some analysts expect the needle to begin to shift over the summer months, as the price of gasoline will no longer be declining on a year over year basis. Other analysts continue to look to that “elusive” spurt higher in wage growth in response to a tightening labor market.
Nevertheless, the odds for a Fed hike are getting lower. Fed funds futures probability index gives a ‘zero’ percent chance of the Fed taking action when they next meet on July 27th, hiking or cutting. In fact, the index doesn’t even hit +30.0% until September 2017.

5. What’s China doing with the yuan?

Aside from Brexit, the market is keenly focusing on developments with the CNY currency (yuan). In the overnight session, the offshore yuan rate fell to its weakest level in six-months with USD/CNH (offshore) testing ¥6.7021. There are reports circulating that the People’s Bank of China (PBoC) is willing to let CNY currency to weaken even further, perhaps to ¥6.8 this year – that would equal last years record decline of -4.5%.

For now, the Chinese currency has managed to move off its worst level of the overnight session on reports that China state-owned Chinese banks were selling dollars on behalf of the PBoC to help stabilize onshore yuan.

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