Friday, July 1, 2016

Brexit Turmoil Fades, For Now Weekly Market Update: Brexit Turmoil Fades, For Now
Fri, 01 Jul 2016 16:30 PM EST

Global markets began the week under a dark cloud of uncertainty in the wake of the UK voters' decision to leave the EU. On Monday investors continued to flee from risk assets as ratings agencies cut the UK's sovereign ratings, European banking stocks got pummeled, and the British Pound hit new 30 year lows. Uncertainty persisted about the timing and path forward on separation from the European Union, and the leadership transition in the Conservative Party (and perhaps also the Labour Party) dominated the conversation in London along with the markets' reaction. The S&P traded down through the 200 day moving average for the first time since March and money surged into global bonds markets sending US Treasury yields to levels not seen since 2012. The Brexit vote propelled gold to a new 15-month high above $1,300, and pound sterling remained under pressure. Cooler heads prevailed by the end of the week and stocks reversed higher. For the week the DJIA gained 3.1%, the S&P500 rose 3.2%, and the Nasdaq added 3.3%, while the UK's FTSE-100 surged over 7%, notching its best performing week in nearly five years.

At the opening bell on Tuesday, though, confidence was resurfacing as investors took a step back to fully evaluate the landscape. Despite somewhat tougher talk by European officials it was becoming clear that the UK government had no intention of invoking article 50 before a new PM is installed. Hope built that the resulting 2+ years before any agreement needs to be reached should allow cooler heads to prevail and officials to hammer out a mutually beneficial trade pacts. Policymaker responses also went a long way to underpin improving sentiment. Central bankers from around the world chimed in they were prepared to take measures to ensure liquidity and proper functioning of financial markets. South Korea announced a $17B stimulus package and China's president Li pledged he won't allow a rollercoaster ride in Chinese capital markets. Importantly, despite the surge in volatility there were no reports of dislocations in the capital markets or the global banking system. On Thursday the BOE's Carney plainly stated that further easing was likely this summer and that only solidified the growing belief the US Fed was likely on hold through year end. The notion the UK vote would keep central banks rates lower for even longer than previously thought helped fuel a dramatic rebound in equity markets.

By Friday most major stock indices had returned to levels seen heading into the UK vote but the flow of money into government bond markets had yet to really subside. The FTSE was the first to recapture its post Brexit losses while the GBP remained devalued by ~13%. The 10-year GILT went for wild ride and by weeks end the yield touched record lows below 0.9%. German Bund yields fell further into the negative territory while the Euro rebounded from a 1.09 low to stabilize around 1.11. US stocks surged into the end of the quarter aided calming words from central banks and a slew of M&A announcements. The US 10-year yield slipped more than 10 basis points since Friday's close to trade sub 1.5%, and remains down more than 20 basis points from where it stood before the UK vote. The US Dollar index is holding up about 2.5% since the Brexit vote.

Asia's FX flows were just as volatile as the Brexit effects played out. The USD/JPY after briefly trading below 99 on Friday, retraced back above 103 on improving risk sentiment. Verbal intervention remained heavy in Japan, where PM Abe held a meeting with BOJ Deputy Governor Nakaso and Finance Minister Aso. The PBoC's first fixing after the Brexit set the Yuan at 6.65, the lowest setting since Dec 2010. An intraday spike up above 6.70 sparked rumors that PBOC officials were willing to tolerate USD/CNY as high as 6.75.

Data for the week was mixed and ultimately overshadowed by the Brexit news in terms of any market-moving effect, but some key data points were notable. The US Markit services PMI report was a bit more subdued than estimated, noting any rebound in the economy from the weak first quarter was largely confined to April, and that growth has since faded again. The Commerce Department revised first quarter GDP growth upwards from an annual rate of 0.8% to 1.1%, which is still the weakest pace in a year, portending the US economy remains vulnerable to global externalities. On the other hand, the Chicago PMI reading surged in June to its highest reading since January 2015, with managers noting improved production and new orders. US initial jobless claims came in slightly above estimates but remained at a level consistent with a healthy labor market, as the reading remained below 300K for the 69th consecutive week. US consumer confidence rebounded in June according to the Conference Board; however, it's important to note this data was gathered up to a week before the Brexit vote.

In deal news this week, it was disclosed that Hershey was in talks with Mondelez but it rejected a $107/share offer of equally proportioned cash and stock and determined that the offer "provided no basis for further discussion." Nevertheless, shares of Hershey and other US foods producers rose sharply on Thursday on the prospects of more M&A in the sector. After years of winking at each other Lionsgate and Starz finally tied the knot, in a $4.4B merger deal creating a bigger player in the content world. Private equity also got into the act this week as Apollo Global bought Diamond Resorts for $2.2B, paying a 26% premium.