Daily Market Update: Project Turmoil
So, the UK has voted to leave the EU.
For now, it means no change, as David Cameron signalled that his successor decides whether to trigger Article 50 of the Lisbon Treaty. The timescale that David Cameron has suggested would see a new Prime Minister unveiled at the Conservative Party conference in October. Only when Article 50 is triggered does the clock start to tick on two years of negotiation for the UK’s exit from the EU. Over the weekend, however, some EU leaders called for divorce proceedings to start immediately. Although the German Chancellor, Angela Merkel, has sought to soothe tensions amongst her EU counterparts and within her own government and counter some of their impatience. "Quite honestly, it should not take ages, that is true, but I would not fight now for a short time frame," Merkel told a news conference on Saturday. "The negotiations must take place in a business-like, good climate," she said. "Britain will remain a close partner, with which we are linked economically." This morning it is reported that Angela Merkel and Francois Hollande are in “full agreement” on how to handle the fallout from the UK’s decision to leave the EU. Meanwhile strains within the UK Labour Party have also emerged with calls for Jeremy Corbyn to stand down. Corbyn sacked one of his front bench team which has been followed by a series of resignations (11 at the last count) yesterday within his Shadow Cabinet. Scottish First Minister Nicola Sturgeon has also suggested that Holyrood could veto Brexit. Clearly there is no shortage of political risk and uncertainty within the UK and this is expected to weigh on sterling assets in the week ahead.
On Friday, we saw significant volatility and price action on financial markets with heavy falls in UK equities and a slump in sterling. Moody’s has lowered the outlook on UK’s Aa1 credit rating to negative from stable. The FTSE 100 initially fell by almost 9% before recovering and closing some 3.2% lower. However, UK stocks were actually up 2% over the course of the week. Financial stocks posted the largest declines with falls of over 10%. The real impact was evident on the next tier of UK companies with the FTSE 250 (top 250 companies) falling 7.2%, the largest daily decline since 1987. The FTSE 250 is a better indicator of the UK domestic economy as the weaker pound boosts the overseas revenues from these larger companies. UK equities fared better than their European equivalents. The Euro Stoxx index fell by almost 9% with banking stocks falling by over twice this figure. The Eurozone core fared better than the periphery with the Spanish and Italian exchanges down over 12%. Ireland’s ISEQ fell by almost 8% on Friday. Wall Street picked up the baton on Friday afternoon with the S&P 500 3.6% lower at the closing bell. Overnight in Asia, Japanese stocks have rebounded 2.4% following Fridays 8% fall. European stocks (Euro Stoxx) are up 0.2% in early trading though the ISEQ is down 2.6%. The FTSE 100 and FTSE 250 are down 0.6% and 1.5% respectively. The flight to safety has seen safe-haven assets such as gold and government bond markets rally. Gold jumped almost 5% on Friday, its best one day rally since 2009. Meanwhile the yield or interest rate (which moves inversely to price) on 10-yr UK, Japanese and German government debt have hit new record lows.
Sterling suffered a record one-day loss on Friday with the pound dropping 8.1% against the US dollar to $1.367. This record one-day loss was almost double the 4.1% decline on Black Wednesday in 1992 when the UK exited the Exchange Rate Mechanism (ERM). This also took cable to its lowest level since 1985. This morning the pound has extended its losses by a further 2% as I write. The currency pair is currently changing hands at $1.339. Sterling’s price action against the euro has been less marked but still significant. EUR/GBP was at 76.5p prior to the EU referendum result and is now trading at 82.6p. This is 1p higher than Friday’s close. We can expect further sterling weakness in the days / weeks ahead to 85p and even higher. Similarly cable is expected to push towards $1.30 in the near-term. UK interest rate expectations are pushing lower which in turn is driving sterling lower. Longer-term interest rates 5yr swap rates have fallen by 37bps since last Wednesday and are trading at a record low of 0.72%. The front-end of the curve (i.e. next year or two) is pricing in Bank of England interest rate cuts. Be prepared for the Bank of England to cut its Bank rate from 0.5% on the 14th July. It would be the first move in 7½ years. EUR/USD continues to trade around the $1.105 mark. The currency pair had hit $1.14 prior to the referendum result.
Some of the world’s largest central banks offered financial backstops to allay concerns in financial markets. The Bank of England offered to provide more than £250bn to meet foreign currency needs with the Federal Reserve and the ECB standing ready to provide necessary liquidity if required. "The Bank (of England) will not hesitate to take additional measures as required as those markets adjust and the UK economy moves forward," Carney said, warning that economic volatility can be expected as Britain adjusts. The UK Chancellor, speaking this morning, has warned of continued market volatility but says the UK is well placed to weather Brexit storm. The Treasury and the Bank of England have “well thought through contingency plans”.
Overnight in Spain, the opinion polls and exit polls have been proved wrong again. The far left Podemos party did not make the gains that had been expected. The market friendly result still revealed a hung parliament but incumbent Rajoy’s PP party gained 14 seats relative to December’s election. A PP-led coalition government now looks likely. The yield on 10-yr Spanish government debt has tightened by 10bps this morning - a positive sign.
Janet Yellen, Mario Draghi and Mark Carney were all due in Portugal today for the start of a three-day ECB forum on central banking. However, the Bank of England Governor will now not attend. Both Yellen and Draghi are scheduled to talk this evening. Negative interest rates and the aftermath of the UK’s referendum will be among the issues discussed. The latter will remain front and centre this week both politically and in terms of financial markets. EU leaders are due to hold a two-day summit in Brussels, starting tomorrow, to discuss Brexit. Politics and Brexit news will remain the focus for financial markets today and this week with sterling set to push lower.