- Odds for Brexit are rising along with market nervousness
- Weekly market focus
- FOMC rate hike expectations are deferred this week
Odds for Brexit are rising along with market nervousness — The movement for the UK to leave the EU has been gaining ground and the polls are basically dead even at this point. A poll-of-polls run by WhatUKThinks.org puts the decision at 50-50 versus the previous tilt of a few percentage points for the “remain” crowd. A recent poll by the Financial Times found only a 3 point margin in favor of remaining within the EU.
The betting houses are putting much higher odds on the UK staying in the EU. The website oddschecker.org, which averages all the various betting houses, pegs the odds of the UK remaining in the EU at a high 4/9 (69% probability) and the odds of leaving the UK at only 2/1 (33% probability). It is not clear why bettors are 69% sure that the UK will remain in the EU when the polls are dead even except that bettors apparently don’t think the polls are accurate.
In any case, the financial markets are bracing for the distinct possibility that the UK public on June 23 may vote to leave the EU. The benefits of the EU are not clear to the average person on the street, many of whom have become more concerned about open EU borders and the influx of refugees from the Middle East. Yet there will be a substantial cost to the UK if it leaves the EU in terms of reduced investment and businesses moving out of the UK to continental Europe. Indeed, business investment fell -2% in the UK in Q4 as businesses pulled back to await the June 23 Brexit vote.
Against the dollar, sterling has fallen sharply by -15% in the past 1-3/4 years to post a 7-year low of $1.4667 in February. That was just modestly above the 30-year low of $1.3503 posted in early 2009 in the wake of the financial crisis. Against the euro, sterling has fall sharply by -14% in the past six months to post a new 1-3/4 year low.
Regarding Brexit, the global markets are much concerned about the damage for the Eurozone than they are about the domestic impact on the UK if citizens vote to leave the EU. The Eurozone debt crisis is still lurking in the background and has only been held in abeyance by the market confidence that the ECB has managed to instill that it will do whatever it takes to preserve the euro. Yet market confidence can evaporate quickly and the further spread of Euroskeptic politics in the EU countries could yet revive market contagion.
The spread of Euroskeptic politics was underscored just this week when the Dutch rejected the EU-Ukraine trade deal, which was a huge blow to the EU and a big win for Russia. The Eurozone was torn apart by the Eurozone debt crisis, which led voters in troubled countries to be angry about the austerity measures imposed on them by the rich Eurozone countries, while voters in the rich Eurozone countries were angry about being forced to bail out the financially irresponsible EU countries. The markets are unsure whether the Eurozone will be able to survive intact and the UK’s withdrawal from the EU would certainly not be a good precedent.
Would a Brexit vote cause a systemic crisis in Europe? Probably not since the UK would simply be leaving the EU common market and not the Eurozone currency union. However, Europe is still skating on thin ice after the Eurozone debt crisis and currently needs stability and confidence, not fuel for the dark anti-austerity and Euroskeptic forces.
Weekly market focus — The markets next week will focus on (1) Thursday’s Chinese Q1 GDP report, which is expected to ease to a new 7-year low of +6.7% from +6.8% in Q4, (2) six appearances by various Fed officials and whether there is any shift in expectations for Fed policy, (3) the Treasury’s sale of 3-year, 10-year and 30-year securities, (4) the beginning of Q1 earnings season with Alcoa reporting on Monday, and (5) a fairly busy U.S. economic calendar.
Key U.S. economic reports next week include (1) Wednesday’s March retail sales report (expected +0.2% and +0.4% ex-autos), (2) Wednesday’s March final demand PPI report (expected +0.3% y/y headline and +1.3% y/y core vs Feb’s +0.3% and +1.2%, respectively), (3) Wednesday’s Fed Beige Book report, (4) Thursday’s March CPI (expected +1.1% y/y headline and +2.2% y/y core vs Feb’s +1.0% and +2.3%, respectively), (5) Friday’s March industrial production (expected -0.2% after Feb’s -0.5%), and (6) Friday’s preliminary-April U.S. consumer sentiment index from the University of Michigan (expected +1.0 to 92.0 after March’s -0.7 point decline to 91.0).
FOMC rate hike expectations are deferred this week — The federal funds futures curve this week has fallen by 6-13 bp for 2017-18. Tuesday’s March 15-16 FOMC meeting minutes said that “some” FOMC participants indicated that a rate hike at the April FOMC meeting “might well be warranted” if the economic data comes in as expected. However, the overall tone of the minutes was dovish with the statement that, “Many participants expressed a view that the global economic and financial situation still posed appreciable downside risks to the domestic economic outlook.” Those global risks mainly include China and the Brexit vote on June 23.
The market is currently discounting a zero chance of a Fed rate hike at the next FOMC meeting on April 26-27 based on the federal funds futures markets. The chances for a rate hike then ramp up as the year wears on to 18% by June, 32% by July, 46% by September, 60% by November, and 70% by December. The market is not discounting a 100% chance of a Fed rate hike until June 2017.