Article / 02 June 2016 at 12:56 GMT

Daily Shot: UK inflation expectations drop on Brexit worries Team / Saxo Bank
  • Brexit risk dwarves Scottish independence vote in terms of GBP volatility
  • Yields on longer-dated gilts down sharply on heightened risk aversion
  • UK inflation expectations are down; market views Brexit as deflationary
  • Irish manufacturing activity softening at least partly due to Brexit concerns
  • Swiss 10-year yield hovers near lows; GDP growth below consensus
  • 70% of German government bonds now have negative yields
  • Greek banks unlikely to be able to access cheap LTRO/MRO financing
  • China's effort to internationalise CNY failing; offshore yuan deposits down sharply

By Walter Kurtz*

We begin with the UK where the EU referendum concerns are front and centre again. The Brexit risk now dwarves the Scottish independence vote and the UK general elections (the CBOE British Pound Implied Volatility Index shown below). 

GPB Volatility

Similarly, the 1-month GBP risk reversals are at levels we haven't seen even during the 2008 financial crisis. 

GBP 1-mth risk reversals Source: @auaurelija, Risk Reversal = Implied Volatility on OTM Call – Implied Volatility on OTM Put (vol "smile" asymmetry) 

The British pound is down for the second day. 

Cable (GBPUSD)
Source: @barchart 

The yield on longer-dated gilts fell sharply on heightened risk aversion.

UK yields

As a result of the above, the UK longer-dated inflation expectations have dropped to the lowest level in over a year. The market sees Brexit as being deflationary for Britain.

UK inflation outlook
Source: @ecoeurope, @anoojad

The betting markets-based Brexit spread is still quite wide but has been tightening in the past couple of days. 

Brexit odds Source: @PredictWise

Separately, UK mortgage approvals and the overall mortgage lending slowed. The stamp duty hike has pulled a significant amount of the house purchase activity forward. 

UK Mortgage approvals

UK Mortgage lending Source: 

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As discussed yesterday, one of the EU nations that will be significantly impacted by Brexit is Ireland. We already see Ireland's manufacturing activity softening at least in part due to Brexit concerns.

Ireland manufacturing PMI Source:, @MarkitEconomics

Irish manufacturing commentary

Source: @MarkitEconomics 

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Elsewhere in Europe, the Swiss 10-year government bond yield is hovering near the lows. Swiss GDP growth and retail sales came in below consensus on Wednesday and concerns about deflationary pressures persit.

Swiss 10YR

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In the Eurozone, Germany sold 5-year government bonds at record low yield - deep in negative territory. 

Germany 5YR

In fact, 70% of German government paper now has negative yields. 

Most German yields negative

Source: @BarkowConsult  

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It doesn't look as though Greek banks will be able to access cheap LTRO/MRO financing by pledging Greek government bonds -- at least for now. 

Greek banks
Source: Reuters

Greek banks desperately need access to this financing after last year's sharp drop in deposits. 

Greek banks
Source: ‏@fastFT

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It seems that the Japanese government decided to wait on implementing another consumption tax hike. USDJPY dropped in response (yen rose), sending the Nikkei lower. 

USDJPY Source: @barchart  

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We start the EMG set with China where the broad (M2) and the narrow (M1) money supply growth has diverged. Will the recent Beijing-engineered liquidity boost make it into the "main street" economy or stay within the financial system? 

China money supply Source: Federal Reserve Economic Data

China's effort to internationalise the yuan is failing. The offshore yuan deposits have declined sharply due to further devaluation concerns. Given Beijing's crackdown on yuan shorting, hedging yuan-denominated portfolios has become difficult. Welcome to the "unintended consequences" of blunt regulatory intervention. 

Dwindling yuan deposits
Source: ‏@fion_li, @business, @frostyhk 

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Speaking of manufacturing, factories are struggling globally. The JPMorgan Global Manufacturing PMI has "flatlined". 

JPMorgan global manufacturing PMI Source: @MarkitEconomics 

There seems to be a strong relationship between the JPMorgan global manufacturing index and US longer-term treasury yields. That would suggest that as long as long as global manufacturing activity remains in the doldrums, longer treasury yields will stay low (even as the Fed raises rates). That would argue for a further flattening of the treasury curve. 

Global manufacturing and US rates

Source: ‏@boes_  

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Back in the United States, another measure of manufacturing activity, the ISM PMI, came in somewhat stronger than expected.

 Source: Federal Reserve Economic Data

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 And finally, in Food for Thought:

Sales of safes in Japan in response to negative interest rates.

Food for Thought

Source: Deutsche Bank, @chartoftheday, Business Insider 

Cash on corporate balance sheets by US firm.

Food for Thought
Source: @StatistaCharts, ‏@JmBadalamenti 

— Edited by John Acher

*Walter Kurtz is a pseudonym

**This is an abridged version of the Daily Shot. To subscribe to the full version, link to the Daily Shot and select the appropriate command. E-mail addresses are never shared with anyone.


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