By Dean Popplewell
Tuesday June 21: Five things the markets are talking about
Current market sentiment remains highly correlated to Brexit speculation. Global bourses are relatively mixed in the overnight session; a day after a strong risk rally was supported by U.K. weekend referendum polls.
Earlier this morning, Sterling (£1.4784) rallied to a new seven-month high, on the perception of diminishing risk that the U.K. referendum on Thursday will result in a vote to leave the E.U.
Two opinion polls overnight put ‘remain’ ahead of ‘leave’, although a YouGov poll still has ‘leave’ in front.
ORB/Telegraph saw the ‘stay’ camp momentum building with a +53% for remain, +46% for ‘leave’ breakdown vs. +48% to remain, +49% to leave last week. YouGov poll: +42% for remain, +44% for leave – two-point lead for ‘leave’ vs. prior seven-point lead.
In reality, polls remain very close, leaving the pound and markets vulnerable to any opinion polls putting ‘leave’ in front. The price moves across the various asset classes can at times be volatile due to a lack of liquidity as most investors stay sidelined before the referendum.
1. Dollar index remains vulnerable
For many Brexit-wary investors, the mighty ‘buck’ has been the safe haven of choice. This choice has helped to support the dollar over some fundamental weaknesses in the past few weeks.
Nevertheless, if the chances of a U.K. departure from the E.U really begin to fall, the dollar’s fundamental flaws may become even more exposed.
Already this month, weaker May U.S. jobs data have dashed rate-hike hopes, and Fed-fund futures show only a +12% probability of an increase in July. Without expectations of tighter U.S. monetary policy near-term or a rush to safe havens, there are fewer reasons for investors to own the dollar.
The U.S. Dollar Index is down -0.7% at 93.55, and if safe-haven flows continue to abate, the index risks a return to last month's low of around 92.
2. U.S. Treasury yields
The outcome of the U.K. referendum will decide the path of global government-bond yields. There is a potential for yields to potentially tumble to new low records in the case of a Brexit.
Treasury yields (10’s +1.67% – last week's low +1.505%) are to remain volatile ahead of Thursday’s vote. If the remain camp prevails, it’s expected that much of the recent flight to own sovereign bonds would unwind even further towards +1.80-85% for 10-year product. Expect yields to be capped due to the veracious overseas appetite for higher returns.
In the event of a Brexit vote, U.S. 10-year yields have the potential to plummet to new record lows around +1.35%. Its U.K. counterparty; 10-year gilts could fall towards +1%, while the bund equivalent could be trading in negative territory.
3. CEE currencies to gain on ‘Bremain’
Collective thinking sees central European currencies recovering from last week’s losses outright to the EUR if the U.K. votes to remain in the EU in Thursday’s vote.
The Polish zloty (PLN) has the strongest potential to appreciate, back towards €4.3000 against the euro, while the Czech koruna (CZK) has practically none given their central bank’s floor for EUR/CZK.
Currently, the CZK moves within a tight range outright because of the Czech National Bank intervening to maintain a 27.00 floor, leaving it less vulnerable to sharp moves following the U.K.’s referendum.
In the case of Brexit, central banks in Croatia, Romania and Serbia are expected to intervene to reduce currency volatility. Both the Hungarian central bank (MNP) and the National Bank of Poland are expected to only take action in case of excessive market turbulence.
4. Yellen’s testimony before the Senate banking committee
Later this morning, the Fed’s Yellen appears before the Senate Banking Committee for her semi-annual monetary policy testimony (10am EDT), and tomorrow the Fed Chair will return to the Hill for round two before the House Financial Services Committee.
Expect Ms. Yellen to face a grilling on a range of issues – economic effects of bank regulation, cyber security and the Fed’s focus on global developments in setting U.S. monetary policy.
The Fed Chief is expected to repeat the comments she made at last week’s FOMC press conference. Nevertheless, expect her to be pressed to explain the reversal in officials’ thinking from just a month ago.
How did U.S. officials go from ‘implying’ a potential rate increase to a “quite uncertain” outcome so quickly? Last week, the Fed highlighted global concerns (Brexit vote) as a factor not to raise rates. This only came in Yellen’s press conference and not in the Fed’s accompanying policy statement.
5. German court rejects legal challenge to ECB bond buying
Earlier this morning, Germany’s top court ruled that the unlimited bond-buying program (OMT) created by the ECB complies with German law. This is a massive victory for ECB’s President Draghi over his most vocal of German critics. Note, it’s not the last legal challenge; there are four more German lawsuits still pending.
This program was setup within weeks of Draghi’s pledge to do “whatever it takes” (September 2012) to save the EUR. The program has never been used, but the possibility of available funds to buy peripheral Eurozone bonds has always been credited to restoring investors’ confidence in the EUR.