How Windy Is It . . . ? Monday, 6th June 2016 – No.182
Will they or won’t they?
One of the observed behavioural finance traits is that people place too much weight on the most recent piece of information rather than looking at longer term data and reviewing the latest piece in context of that longer term. Last week was dominated by a number of potential hurdles for markets to jump. Some passed without much event, the oil price remained around US$50 after the OPEC meeting and there were no shocks emanating from the European Central Bank meeting on the same day, while others still possess the power to shock and destabilise. The ‘Brexit’ vote is a prime example of the former while the other ‘will they won’t they?’ related to the future intentions of the US Federal reserve. Markets had been trying to assess whether the ‘Fed’ would again tighten monetary policy at its June meeting. Until Friday economic data suggested that a tightening was possible albeit still not a probability.
Friday’s unemployment report changed perceptions as it was significantly weaker than expected, the US economy only generated 38,000 jobs against expectations of 162,000. A strike by Verizon workers accounted for 35,000 jobs but this doesn’t account for what seems a rapid deceleration in jobs growth. Furthermore, the previous two months’ readings were revised down by a net 59,000 while the seemingly positive good news of a fall in unemployment from 5% to 4.7% was driven by a big fall in the labour force. Markets now perceive almost no chance of an increase in US short term interest rates. The chart below traces market expectations and as you can see these fell sharply to a current reading of just 4%. The can appears to have once again been kicked down the road and investors are now assessing whether an increase is now likely at the July meeting or whether US monetary policy is now on hold until later in the autumn or towards Christmas?
So what are the possible effects of a vote to leave Europe? Lawrence Summers, the former US Treasury Secretary writing in today’s Financial Times examines the similarities between the Brexit vote and the possibility of Donald Trump winning the presidential election in November. In his article he asserts that ‘Analysis of option pricing suggests that if Britain votes to leave the EU, sterling could easily fall by more than 10% and the British stock market by almost as much’. He adds ‘it is widely believed that the uncertainties associated with Brexit are consequential enough to affect the policies of the Federal Reserve and other major central banks. He is even more gloomy about the consequences of a Trump presidency.
So it seems likely that a ‘leave’ vote would not only be very expensive for Britain and all her subjects but could also send ripples much wider through the rest of world markets. Let’s hope that the Leave campaigners don’t look back and think ‘be careful what you wish for’.