The Pounds Relief Rally is Officially Over

Tuesday July 5: Five things the markets are talking about

Post Brexit jitters this morning has returned to hurt the pound, putting an end to last week’s relief rally, and push sterling to a new two-and-a-half year low against the EUR.

Today’s instigators are the news of Standard Life Investments suspending trading in a large U.K. commercial real-estate fund due to investors pulling money out after Britain’s vote to leave the EU. Coupled with a survey highlighting the fragility of U.K business confidence after the historic June 23 vote is again creating a sense of nervousness amongst global investors that anything British at the moment comes with a warning sign.

This morning’s Bank of England (BoE) financial stability report will be key for both dealers and investors who seek clues on the central bank’s response to the impact of Britain’s vote to leave the EU. Governor Carney has already mentioned last week the possibility of further monetary easing over the summer from the “Old Lady.” Will the report back up Carney’s personal comments?

1. BoE warns of threats to financial stability

In its Financial Stability Review, just released ahead of the open stateside, the Bank of England (BoE) has highlighted a number of threats to the U.K’s financial stability arising from Britain’s vote to leave the EU.

Policy makers seem to be focusing on three key areas – real estate, employment and household finances.

The report highlights the possibility that capital inflows will continue to fall, which in turn will put “further downward pressure” on the pound and raise the cost of finance for U.K. businesses. The most vulnerable sector they have identified is commercial real estate. The BoE said it’s possible open-ended commercial property may be forced to sell assets in order to meet redemptions.

The BoE has noted that some U.K households will struggle to make debt repayments if there is a rise in unemployment following the Brexit vote. U.K policy makers are also wary that growth in the eurozone and global economies may be weakened, which could hit demand for U.K. exports and affect some U.K. bank loans to borrowers outside the country.

All in all, not a pretty picture the BoE is painting and the odds for further easing in August continue to firm.

2. Equities under pressure as investors turn cautious

Global equities and crude oil prices are under pressure in this holiday shortened trading week. Risk aversion has gold ($1,347) and the yen (¥101.71) climbing as investors turn cautious following last week’s rally.

The Stoxx Europe 600 is off -1% in early trade, building on yesterday’s losses as bank shares fell for a second day. Energy and mining stocks also suffered as Brent crude oil has dropped -1.8% to $49.00 a barrel.

Europe’s banks shares are valued at levels that signal “distress.” Since June 23, an index of European banks has dropped -17%, bringing total losses from the beginning of the year to -30%. Europe’s main headache is currently Italian banks.

In Asia, Japan’s Nikkei stock average fell -0.7%, snapping a six-session winning streak, as the yen climbed against the dollar. Stocks in Hong Kong fell -1.2% while Aussie shares fell -1% after Reserve Bank of Australia (RBA) left its cash rate unchanged as expected (+1.75%).

Indices: Stoxx50 -1.7% at 2,818, FTSE -0.6% at 6,486, DAX -1.5% at 9,563, CAC-40 -1.6% at 4,167, IBEX-35 -1.8% at 8,106, FTSE MIB -1.1% at 15,839, SMI -1.0% at 7,975, S&P 500 Futures -0.6%

3. Eurozone yields to ‘temporarily’ rise due to supply

Sovereign bond yields are trying to back up in the euro zone, the first time in a week, as fixed income dealers make room to take down an additional €20b of bond supply. Prior to this week, global sovereign have been under pressure, with a number of countries reporting record low yield prints after the June 23 Brexit shock vote. U.S 10-year’s hit fresh lows yesterday – the bid yield fell as low as +1.382%.

Austria (issues +€1.1B today), Germany (holds a two-year sale tomorrow), Spain (potential new 10-year debt issue Thursday) and France (issues +€9-10b long bonds Thursday) are all due to hold auctions this week. Bond yields have come under extraordinary pressure of late, mostly on the back of dealers trying to get ahead of potential further easing from the European Central Bank (ECB) and Bank of England (BoE) in particular.

An example of the volatility being witnessed in fixed income is Spanish debt. Spain’s 10-year bond yields, which rallied after the British vote as investors dumped risk assets, have plummeted -46 bps since and even ended last week with their biggest weekly fall in almost four-years.

With cheap funding costs it’s no real surprise to see a rush to bring supply to market.

4. Aussie Elections

Australia has become the latest country plunged into political uncertainty after last weekend’s general election delivered an inconclusive result. This is raising the possibility of fresh elections.

Neither the Liberal-National coalition nor the opposition Labor Party have won enough seats to form a government after Saturday’s federal election. Aussie PM Turnbull said +70% of the votes have been counted and warned there would be a few more days of counting.

S&P has already suggested that it could cut the ‘AAA’ sovereign rating if Aussie parliamentary gridlock on the budget continues. For Moody’s, the primary risk to the country’s Aaa’ sovereign rating would come if the sworn-in party showed a lack of interest in returning the country’s budget to a surplus over the medium-term. According to Fitch, the agency has voiced their concerns of an ongoing political deadlock.

The RBA as expected, kept rates unchanged at +1.75% and their policy statement was also left similar to last meeting.

5. Swiss National Bank (SNB) data suggest currency intervention


It’s no really much of a surprise to see the latest Swiss National Bank (SNB) data suggesting there was a healthy amount of currency intervention by the central bank last week.

The average sight deposits of domestic Swiss banks for the week ended July 1 were +$430.3 billion, up from +$423.5 billion in the previous week (June 24) and +$416.5 billion the week before that.

Note, the sight deposits are not a direct proxy, due to the valuation effects, but dealers do suggest that a sizeable change is a strong signal of central bank intervention. The SNB announced on June 24, a day after the shocking Brexit vote outcome that the bank had intervened in the currency market to cap the CHF’s rise – an unfamiliar act by the SNB, but a necessary shot across the bow for this historical risk aversion currency of choice ($0.9715).

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