Volatility falls after Comey, ECB, and Italian election news, but then shocking UK exit poll emerged late
ECB moves toward more neutral guidance but maintains dovish tone
UK exit polls look bad for Conservatives
Volatility falls after Comey, ECB, and Italian election news, but then shocking UK exit poll emerged late — Thursday produced roughly the expected results for the Comey testimony and the ECB meeting, helping to push volatility lower. The S&P 500 VIX index on Thursday fell by -0.23 points to 10.16% and the 10-year T-note TYVIX fell by -0.12 points to 4.38%.
Volatility also eased on Thursday as a snap Italian election this autumn now looks unlikely after a political deal on electoral reform fell apart. The main Italian parties just a few weeks ago thought they had an electoral deal in hand, which could have paved the way for new elections this autumn. If there is no electoral deal, however, then Italian elections are not likely until early 2018 with a deadline of May 2018. The markets are fearful of Italian elections because the anti-EU Five Star Movement party is polling well and has a chance of taking over the government and calling for a voter referendum on leaving the euro. The Italian MIB stock index on Thursday rallied sharply by +1.46% on the reduced likelihood of an autumn election.
Volatility may perk up on Friday, however, after the shocking UK exit polls were released at around 5PM ET, i.e., after the U.S. markets closed. The exit polls indicated that Conservatives did not receive a majority of the seats in Parliament. If correct, the result would be UK political chaos and a possible delay in Brexit negotiations.
Other near-term events that are supporting volatility include this Sunday’s first round of French legislative elections and next week’s FOMC meeting. The odds of an FOMC rate hike next week are essentially at 100%, with the main question being whether the FOMC might also release some parameters of its planned balance sheet reduction later this year.
Thursday’s Senate Intel Committee hearings with former FBI Director Comey went about as expected with partisan disagreement about whether President Trump’s requests for Mr. Comey to end the Flynn investigation rose to the level of obstruction of justice. It appears that it would take much more damning evidence of wrongdoing before Congress might move towards impeaching President Trump. Indeed, the betting odds that President Trump will still be president at the end of 2018 rose by +3 points to 62% on Thursday from 59% on Wednesday, according to PredictIt.org.
ECB moves toward more neutral guidance but maintains dovish tone — The ECB at its meeting on Thursday left its interest rates and QE policy unchanged but moved to more neutral guidance, which was in line with market expectations. EUR/USD closed -0.38% lower on Thursday after the ECB meeting on some long liquidation pressure tied to the dovish tone of the meeting. EUR/USD also fell as the ECB reiterated its pledge to boost its QE program if the economy deteriorates.
Regarding the guidance, the ECB said that the “risks around the growth outlook are considered to be broadly balanced,” dropping its former view that the risks were “still tilted to the downside.” That change was in line with market expectations.
The ECB also dropped its reference to “lower” interest rates in its prior guidance that interest rates will stay at “present or lower levels” until “well past” the end of quantitative easing. The guidance now reads, “The Governing Council expects the key ECB interest rates to remain at their present levels for an extended period of time, and well past the horizon of the net asset purchases.” ECB President Draghi said the ECB dropped the reference to lower rates because, “Deflation risks have definitely gone away.” The market consensus is that the ECB will not raise interest rates until Q3-2018.
The ECB cut its inflation forecasts for 2017-2019, indicating that the ECB sees no chance that inflation will rise to its target of just below 2% over the next several years. The ECB cut its inflation forecasts to +1.5% from +1.7% for 2017, to +1.3% from +1.6% in 2018, and to +1.6% from +1.7% for 2019.
Mr. Draghi said ECB members did not discuss when to announce changes to its QE program but that one or two members thought those discussions should begin. The market consensus is that the ECB at its September meeting will announce that its QE program will be tapered down to zero during the first half of 2018.
While the ECB adopted more neutral guidance language at Thursday’s meeting, ECB President Draghi stressed that the Eurozone economy still needs substantial monetary support and that patience is needed for the ECB to meet its policy goals. The bottom line for the meeting is that ECB policy is likely to be quiet for the next few months in the run-up to September’s meeting, when the ECB might announce QE tapering.
UK exit polls look bad for Conservatives — The UK exit polls, which are usually close to the final result, showed that Conservatives won only 314 seats in Parliament, which would be short of a majority in the 650-seat Parliament. If true, Conservatives would have to govern in a coalition with a smaller party or allow Labour to try to form a coalition. Theresa May’s job as leader of the Conservatives may also be in doubt since her party had a 20 point lead at the beginning of the campaign. The election result could result in a delay in Brexit negotiations, which are due to begin on June 19. Sterling plunged by as much as -1.9% when the UK exit poll was released at about 5PM ET. U.S. Sep E-mini S&Ps were mildly lower by -0.2% early Thursday evening after the UK exit poll was released.