- Weekly market focus
- FOMC this week will leave rates unchanged but will not back off its intent to slowly raise interest rates
- Markets confront possibility of Brexit as latest poll shows “Leave” vote with a 10-point advantage
Weekly market focus — The markets this week will focus on (1) whether the FOMC at its 2-day meeting on Tue/Wed provides any hints on the timing of its next rate hike as the odds are near zero for a rate hike this week, (2) nervousness ahead of next Thursday’s Brexit vote, (3) whether last Friday’s sell-off in the stock market is the beginning of a larger downside correction that could last into next week’s Brexit vote, (4) whether last Friday’s -3% sell-off in crude oil also represents the beginning of a larger downside correction, (5) whether tomorrow’s May U.S. retail sales report shows the expected increase of +0.3% and indicates that April’s +1.3% surge was not a one-time shot, and (6) the remainder of this week’s fairly busy U.S. economic schedule, which is expected to show mixed economic results and stable inflation. Only two of the S&P 500 companies report earnings this week, i.e., Oracle and Kroger on Thursday.
In overseas events this week, the market is expecting the Bank of Japan at its policy meeting on Thursday to leave its monetary policy unchanged as it assesses the impact of its already-existing massive stimulus measures. The Bank of England at its policy meeting on Thursday is expected to leave rates unchanged even as it prepares for a possible rate cut after next Thursday’s Brexit vote if UK citizens vote to leave the EU and the UK economy thereafter falls into the expected recession.
FOMC this week will leave rates unchanged but will not back off its intent to slowly raise interest rates — Just two weeks ago, FOMC hawks were loudly proclaiming that the June 14-15 meeting would be a “live” meeting for a rate hike and the April 26-27 FOMC minutes indicated that a majority of FOMC members were leaning toward a near-term rate hike. However, the June 3 May payroll report of only +38,000 (+73,000 ex-Verizon strike) then surprised the FOMC and caused the markets to reduce the chances for a rate hike at the June meeting to zero from 22% before the payroll report. U.S. payroll growth progressively weakened to +186,00 in March, +123,000 in April, and +73,000 (ex-Verizon strike) in May, raising the possibility of a sustained slowdown in hiring that would hurt consumer confidence and spending.
The slowdown in hiring may be only a lagged and temporary reaction to the weak GDP growth seen in Q4 (+1.4%) and Q1 (+0.8%) and hiring could pick back up with expectations for a recovery in GDP growth to at least +2.5% in Q2. However, the Fed cannot count on that recovery in job growth and therefore has no choice but to leave rates unchanged this week and wait for further labor market data. The FOMC is also under pressure to leave rates unchanged this week since a rate hike would grease the skids for an even bigger sell-off in global stocks next week if UK citizens end up voting to leave the EU.
After this week’s FOMC meeting, the federal funds market is discounting the odds for a rate hike at the next FOMC meeting on July 26-27 at only 16%, down from 62% before the June 3 May payroll report. The odds for a July rate hike are still relatively low because the FOMC by that meeting will have only one additional payroll report (i.e., June) to assess the labor market. After that, the odds for a rate hike rise to 34% for the next meeting on Sep 20-21.
The Fed’s rate-hike path depends to a significant degree on next Thursday’s Brexit vote. If UK citizens vote to leave the EU and the global markets plunge on a sustained basis, then the Fed’s rate-hike regime will obviously be further delayed. However, if UK citizens vote to remain in the EU, or if the fall-out from a Leave vote is limited, then the chances will rise for a near-term Fed rate hike.
Markets confront possibility of Brexit as latest poll shows “Leave” vote with a 10-point advantage — Sterling took a hit last Friday after a poll conduct by ORB for the Independent newspaper showed the “Leave” vote at 55%, up by 4 points from the previous poll in April and 10 points ahead of the “Remain” vote of 45%. However, the Brexit polls have been volatile and the “poll of polls” compiled by WhatUKThinks.org still has the vote count little changed at exactly 50% to 50%. Meanwhile, bettors are still heavily favoring a “Remain” outcome with the odds at 4/11 (73% probability) for a Remain vote and 23/10 for a Leave vote (30% probability), according to the website oddschecker.com. The big divergence between betting odds and public opinion polls indicates that bettors have little faith in the quality of the public opinion polls.
World stock markets last week were visibly shaken by the new public opinion polls showing increased support for a “Leave” vote. The markets will remain on edge ahead the actual vote next Thursday. There is little doubt that if the UK indeed votes to leave the EU, there will be major negative consequences for the UK economy as investment capital dries up and as some businesses leave the UK to relocate back within the EU. Some industries will also be hit with higher tariffs and trade disruptions.
The reaction of the world markets to a “Leave” vote remains highly uncertain. A study released last Friday by the risk-modeling firm Axioma Inc predicted that the European stock market would sell off by a hefty 24% on a Brexit Leave vote. One of the researchers who authored the report expressed the opinion that, “There is an assumption that Brexit is not going to happen — if it happens, no one is mentally fully geared up for it yet.” Indeed, the reaction of the markets to a “Leave” vote would depend heavily on the extent to which global investors had already discounted such a vote. We continue to suspect that the fall-out of a “Leave” would be mostly contained within the UK and to a lesser extent Europe, and that there would be little sustained impact for the U.S. markets and economy.
