Waiting To Brexhale

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Importing fear from the euro zone

Last week was a difficult one for stocks, with multiple factors placing downward pressure on them. First and foremost was growing concern about the potential for Brexit. US investors seem to have been somewhat myopic before last week, more focused on US data and the FOMC decision.

But then polls came out suggesting that a vote to leave the European Union (EU) may very well happen, and with that the Brexit vote came into sharper focus.

Fear has spread in Europe, with stocks coming under pressure - along with key sovereign yields. The fear trade even drove the 10-year German bund down into negative territory last week to its lowest level ever. That, in turn, put pressure on US Treasury yields. It seems that the US is now importing fear from the euro zone.

Central banks contribute to fears

It also seems that the FOMC announcement and accompanying "dot plots" played a role in placing downward pressure on stocks - and the 10-year US Treasury yield. With expectations of very modest growth through 2018, investors may be wondering what the Fed knows that might have made it lower its projections, as well as its policy prescription for the fed funds rate. Perhaps that reflects the reality of lower business investment, increased regulation and other significant headwinds.

Also, hurting stocks are more immediate concerns about the US economy and the possibility of a slowdown or even a recession in the near term. Fears were certainly ignited by the anemic job growth in the May employment situation report. However, other recent data points have also helped raise anxiety levels, including last week's release of the May industrial production report and an elevated level of initial jobless claims.

Adding to anxiety this week should be last Saturday's announcement that the widely respected governor of the Reserve Bank of India, Raghuram Rajan, will not remain for a second term. His departure, which seems to have been more the decision of Prime Minister Narendra Modi that than of Rajan, raises questions about Modi's commitment to structural reforms - and creates uncertainty for emerging market investors.

Conflicting data confounds investors

But all is not negative. Retail sales were solid and beat expectations for the month of May - even if they underwhelmed relative to April. And expectations for second quarter GDP growth remain strong, with the Atlanta Fed GDPNow indicator estimating annualized growth for the quarter at 2.8%.

Currently, the NY Fed Nowcast places growth for the quarter at slightly above 2%.

With conflicting data, investors may be confused about what to think. That has only been compounded by the confusion created by the Fed. Despite tough talk in the weeks leading up to the release of the May jobs' report, the FOMC announcement suggests a more cautious Fed - which is reflected in fed funds futures. The majority of market participants do not expect another rate hike this year - "none and done" in 2016.

It is against this backdrop that we begin the week of June 20, with so much at stake in Thursday's UK vote.

A vote to leave has very significant economic and market implications, which we will be following closely. In particular, we would expect a short-term sell-off in at least UK assets - although there is the potential for contagion. However, a vote to remain also has market implications, likely spurring a relief rally in the UK and likely beyond. Over the next few days, assets are likely to rise and fall with Brexit polling numbers. In addition to death and taxes, it seems we can count on increased volatility as Britons decide the EU's future.