Brexit > Fed (for now)
by Benjamin Streed, Fixed Income, Raymond James
Last weekās market movement was a combination of the Fed and recent Brexit (Britain leaving the European Union) polling, both advocating a broad ārisk offā trade for world markets. A summary of the Fedās meeting minutes: the committee skipped raising rates in June as the markets anticipated, but the details surprised the markets as six officials now anticipate one additional hike this year (up from only a single member in March). The group gave a mixed picture of the US economy with such conflicting statements as āthe pace of improvement in the labor market has slowed while growth in economic activity appears to have picked upā. They also noted an expectation that labor markets will continue to strengthen and although the housing market has improved business investment remains āsoftā. The central bank reaffirmed that interest rates are likely to rise at a āgradualā pace, which now sounds questionable as the major dissenter, Kansas City Fed President Esther George, voting in favor of a pause after advocating for a hike in both March and April. According to the Fed itself, the median projection for the federal funds rate at the end of 2016 remained at 0.875%, implying two quarter-point increases sometime this year (there are four more meetings). Meanwhile, the median long-run projection for the federal funds rate fell to 3.00% from 3.3% in March. The chart below details committee member expectations for the central bank rate. This is colloquially referred to as āthe dot plotā. Notice any major change? Hint, itās in red in the right-hand chart. The dramatic change in expectations from March to June is something to keep an eye on.
Moving across the pond, this week marks one of the first times in recent memory that the markets will not focus their attention on the Fed, but will instead scrutinize every single Brexit poll taken and whether that figure is leaning towards āremainā or āleaveā. Generally speaking, the markets over the last few weeks have seen a general ārisk offā trend as people across the globe worry over the implications for a Britain-less European Union (EU) and whether it would spell the beginning of the end for the regional economic system. There are varying estimates regarding the severity of a Brexit vote, but the consensus agrees that GDP in the area will likely fall across the board while other fringe states (Spain, Greece and Italy) may then be inclined to follow Britain out the door and be the second, third or even fourth dominos to fall.
Monday morning action has turned positive for risk assets (equities higher, bond yields up) as polls have shifted back down toward 50/50 after having been slightly in favor of a āleaveā vote. Estimates from Bloomberg currently show 42% in favor of leaving, 45% āremainā and still 13% undecided. Of course, thereās a pretty wide margin of error in these polls so no real clarity will come until the final count on Thursday. Since the beginning of 2016, as the percentage of āleaveā votes have trended upwards US Treasury yields have seen a trend lower with the 10-year note starting at 2.26% and falling as low as 1.57% last week. Has the Treasury market already priced in a Brexit? Any indication that the country will stay in the EU could produce volatility in the Treasury market. We probably should expect a wild week, but at the same time donāt be surprised if it gets choppy as markets continue to sort this out.
Copyright Ā© Raymond James
