The US dollar reigns supreme across the board, with the recent worries about trade wars apparently being shrugged off amid stable to higher US yields and strong risk appetite in major equity markets.
Article / 22 June 2016 at 12:00 GMT

Irrational exuberance or rational despondence?

Head of Trading / The ECU Group plc
United Kingdom


 No, Brexit hasn't gone away yet. Images: iStock

By Neil Staines

In 1996, the then chairman of the Federal Reserve, Alan Greenspan unleashed the phrase “How do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions…” during a speech on the challenges of central banking. Against the current global macroeconomic backdrop where the challenges to central banking are as acute as ever, yesterday was the current Fed chair Janet Yellen’s "irrational exuberance" moment.

In her semi-annual testimony to congress, she delivered two very clear messages. Firstly, as Yellen painted a cautious and uncertain view of the economy, highlighting the momentum loss in the labour market and weak investment amid slow economic growth, she made it clear that the Fed is not in any hurry to enact further monetary normalisation.

Secondly (and from our perspective most significantly), the accompanying Federal Reserve Monetary Policy Report highlighted that “forward price-to-earnings ratios for equities have increased to a level above their median of the past three decades.” and while admitting that equity valuations may not appear rich to current treasury yields “equity prices are vulnerable to rises in term premiums to more normal levels”. We have argued for several months now that equity prices are overvalued as a function of forward discounting and fully expect that the sentiment offered by the Fed this week will be viewed historically as a the beginning of a (perhaps historically significant) correction in equities.

ECB faces many challenges

One of the European Union's five presidents, Mario Draghi, also spoke yesterday. His message was threefold. Firstly Draghi aimed to calm market concern, by making assurances that the European Central Bank stands “ready for all contingencies on Brexit”. Secondly, aiming to calm economic concern, Draghi stated that ECB action has put the recovery on a more “solid footing” and that “further stimulus is in [the] pipeline” – by this he is referring to the stimulative impact of the nascent corporate QE programme (CSPP), and the imminent TLTRO II auctions (where banks are effectively being paid to borrow money, under certain criteria), NOT preparing markets for further stimulus. Thirdly Mario Draghi reiterated his call for national governments to implement structural reform, stating that the “ECB alone cannot make [the current] cyclical recovery structural”.

He went on to suggest that the monetary union is “incomplete and fragile”. This is not a good platform to deal with the possibility of Brexit (whatever probability you place on such an outcome). Brexit would likely represent the next phase in the Eurozone’s rolling crisis, alongside the as yet unsolved economic, debt and migrant crises.

The ECB really is a central bank that faces challenges (to paraphrase Mr Greenspan): not only has it reached the point of diminishing (or even diminished) returns on its monetary policy toolkit, Mario Draghi’s cries for fiscal help are failing to convince 18 member nations - with varied and disparate national problems - of its merits. 

Against the current backdrop, however, the notion that the Fed may consider equities overvalued or vulnerable, or the notion that the ECB is out of monetary ammunition while its members fight their own (fiscal) battles have had little or no direct impact on financial markets. The reason for this is the Union Jack painted (bemused faced) elephant in the room. Brexit.

Sun stands still

On Monday, the annual summer solstice (from the latin solstitium, or sun stands still) coincided with another celestial event, the strawberry moon - a once in a lifetime event. The UK Referendum, whatever your viewpoint, is also a once in a lifetime event. It is possible that the "Leave" campaign would describe the summer solstice as a day of "never ending sunshine possibilities" and the Remain campaign as "the nights are drawing in; we must prepare for the harsh winter". The electorate remains split

As we approach the referendum, financial market liquidity is likely to dry up. GBP is the likely epicentre, followed by broader FX markets and broader financial markets, and as such there will likely be moves that make little sense, but merely satisfy transactions in a low liquidity environment. It is difficult to gauge the timings of any announcement or statistical result of the Referendum vote, however, it is likely that we will have a pretty good idea (at least as to how close it is) by around 0300 GMT. After some positional adjustments today, for financial markets and the UK, tomorrow the sun will, in all likelihood, (if just for one day) stand still.

– Edited by Clare MacCarthy


Neil Staines is head of trading at The ECU Group


The Saxo Bank Group entities each provide execution-only service and access to permitting a person to view and/or use content available on or via the website is not intended to and does not change or expand on this. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on or as a result of the use of the Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. When trading through your contracting Saxo Bank Group entity will be the counterparty to any trading entered into by you. does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of ourtrading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws. Please read our disclaimers:
- Notification on Non-Independent Invetment Research
- Full disclaimer
- 沪ICP备13028953号-1

Check your inbox for a mail from us to fully activate your profile. No mail? Have us re-send your verification mail