Brexit > Fed (for now)
by Benjamin Streed, Fixed Income, Raymond James
Last week’s market movement was a combination of the Fed and recent Brexit (Britain leaving the European Union) polling, both advocating a broad “risk off” trade for world markets. A summary of the Fed’s 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 “the pace of improvement in the labor market has slowed while growth in economic activity appears to have picked up”. They also noted an expectation that labor markets will continue to strengthen and although the housing market has improved business investment remains “soft”. The central bank reaffirmed that interest rates are likely to rise at a “gradual” 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 “the dot plot”. Notice any major change? Hint, it’s 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 “remain” or “leave”. Generally speaking, the markets over the last few weeks have seen a general “risk off” 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 “leave” vote. Estimates from Bloomberg currently show 42% in favor of leaving, 45% “remain” and still 13% undecided. Of course, there’s 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 “leave” 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 don’t be surprised if it gets choppy as markets continue to sort this out.
Copyright © Raymond James
