Sterling has been dented by the risk of a no-confidence vote in Prime Minister Theresa May. Meanwhile, oil remains bid on persistent Saudi Arabian tensions, and the "old correlation" is back between yields and equities.
Article / 07 July 2016 at 13:10 GMT

We might be at peak Brexit overhang

Head of Trading / The ECU Group plc
United Kingdom

  • Uncertainty towards Britain post-Brexit may have peaked
  • Leadership needed to steer UK towards better future
  • BoE governor Carney has the armoury to prevent calamity
  • Chinese yuan devaluation paces continues unabated


Can I count on your vote then? Theresa May limbering up for the second round. Photo: iStock

By Neil Staines

Last week, on the one week anniversary of the surprise UK ‘Brexit’ vote we wrote “from our perspective, GBP is reaching the pinnacle of uncertainty and we are diligently watching the political and economic backdrop as well as valuation opportunities to buy GBP for the medium term”.

While that moment has not yet arrived, another week has passed and there have been a number of interesting developments, not just for GBP and for the UK but also from a global macro-economic perspective. Our overriding view is that we are currently at (or at least very close to) the height of uncertainty for global financial markets.

Last night witnessed the release of the Federal Reserve minutes from the June FOMC meeting (at which policy was left on hold, as expected). The meeting fell just days before the UK Referendum and while some members pointed to the possibility of faster rate rises further down the line should the economy progress as they expect, the overall mood of the minutes appeared to welcome the referendum and the May employment report weakness (lowest monthly payroll gains since September 2010) as providing sufficient uncertainty (excuse?) for maintaining the ‘super-easy’ status quo.

“The power of the lawyer is in the uncertainty of the law” — Jeremy Bentham

Today brings the final elimination round (semi-final in Euro 2016 speak) of the Conservative Party leadership race. Although with the final outcome not due until September 4, perhaps ‘meander’ is a more fitting verb than ‘race’. With Theresa May, a ‘Bremain’ campaigner (admittedly a remarkably unvocal one), holding a substantial lead in the contest at the current juncture, there is an added element of uncertainty to the Brexit proceedings, negotiations and indeed triggering of Article 50.

“Certainty is the death of wisdom, thought, creativity” — Shekhar Kapur

However, our view is that we are reaching the point at which pessimism towards the UK (and GBP by default), fuelled by uncertainty, is reaching its pinnacle. Prior to the referendum, the UK economy was on a relatively firm footing, growth had slowed somewhat from its solid pace in 2015, and while the uncertainties had (understandably) impacted business confidence and expenditure, consumer activity (and spending) continued to be supported by record employment and low and stable inflation.

While UK equity markets (the narrow globally oriented indexes at the very least) have performed well, banks and financials have been hit hard. However, comparisons to the global financial crisis are overdone.

Capital requirements for the (largest) banks are now 10 times what they were in 2007 and, under Mark Carney, the BoE has the tools and expertise to maintain financial stability (for which increased market liquidity provision and relaxed capital buffers are testament). What the UK needs now is a plan.

A plan to restore confidence in the UK’s ability to maintain and create trading relationships, to attract talent from the EU and the rest of the world and to create an environment to foster creativity and entrepreneurship. If ever there were a time for UK politics to set aside the protocols and etiquette for the sake of the hint of a plan for the UK’s economic progression, surely it is now

“Information is the resolution of uncertainty”  — Claude Shannon

The prolonged decline in the value of the Chinese yuan has been an interesting development of late. Its value has declined significantly beyond the level which brought such consternation to equity and risk asset markets in January / February, yet global equity markets continue to remain extraordinarily buoyed by the prospect of yet further monetary accommodation.

Admittedly, the equity market tumble at the start of the year was fuelled by the fear of accelerating capital flight from China which this mornings FX reserve data suggests is stabilising.


The yuan has been doing some heavy lifting but is
struggling to keep pace with the dollar. Photo: iStock

The Italian (European by default) banking sector, European and Japanese bond markets (and global by default) and global equity markets (particularly, on a valuation basis, US equities) are all becoming increasingly fragile from our perspective and the probability of an abrupt dislocation in current market pricing over the summer months is rising significantly.

It is likely that the key barometers of sentiment in this regard are Italian bond yields, where despite the fact that economic growth since the year 2000 has been broadly zero, despite the fact that the country remains plagued by fiscal deficits and NPL’s above the €200 billion mark, the government can borrow money for two years and be paid around 5 basis points a year for doing so.  

In FX this view likely translates into a negative bias for the EUR and AUD, and while their current progress is frustrating, we expect the pressure to build to the downside, even against GBP, as the year progresses.

— Edited by Martin O'Rourke

Neil Staines is head of trading at The ECU Group


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