Friday, July 8, 2016

Investors Find Brexit Solace in US Equities & Government Bonds Weekly Market Update: Investors Find Brexit Solace in US Equities & Government Bonds
Fri, 08 Jul 2016 16:15 PM EST

Global financial markets remained volatile under the continuing influence of the UK Brexit vote two weeks ago. The 10-year UST yield sank to fresh record lows below 1.35%, and buyers of 50-year Swiss government bonds got ready to accept a negative yield this week as malaise settled over the entire global economy. The pound, which hit a 31-year low against the dollar of 1.2800 on July 6th, gave up recent gains and sank back below 1.3000, while the dollar and yen remained strong. Crude prices sank lower, with WTI back in the $45 handle and Brent back around $46. In the UK, various investment firms suspended redemptions in open-ended property funds as investors rushed to take out their cash, while investors eyed the Italian banking system with deepening concern. On Friday, the very strong June US jobs report lifted stocks broadly to flirt with all-time highs in the S&P. US Treasury yields stayed stubbornly low, as global demand for assets that offer any kind of relative yield remains unwavering. For the week, the DJIA +1.1%, the S&P500 +1.3% and the Nasdaq +1.9%.

The June US jobs report was very strong and may have been good enough to bring forward Fed rate hike expectations after the setback of Brexit. The 287K non-farm gain was way ahead of even the most optimistic estimates, although the result only brings the Q2 average up to +147K, versus +196K in Q1. Unemployment ticked up to 4.9% from 4.7%, however the household survey showed an incremental decline in labor market slack as the participation rate ticked slightly higher.

Global currency markets remained under pressure from the Brexit vote. Sterling slid lower on Monday and Tuesday, then appeared to stabilize around 30-year lows in the second half of the week, but remained firmly below 1.3000. The yen remained a safe haven, with funds flowing into the Japanese currency despite some weak economic data reports. USD/JPY had traded back up to 103.25 last week, but as of Friday the pair was back to the critical 100 level, which was briefly breached during the Brexit vote panic and subsequently held unchallenged. The volatility prompted Vice Finance Minister & FX Chief Asakawa to warn the government was "closely watching" FX markets with urgency and would act promptly if there were "speculative moves." EUR/USD was steadier and held above the 1.100 level.

The second-order effects of the Brexit vote further dampened confidence. Seven UK investment firms suspended trading in property funds this week, freezing £15 billion of assets since Monday, out of a total of £24 billion invested in UK open-end real estate funds. Many comparisons were made to the failure of Bear Stearns' hedge funds in the summer of 2007, although the total amount held in such property funds is extremely modest. Press reports asserted that funds Henderson, Columbia Threadneedle and Aberdeen were maintaining positive cash balances but chose to halt withdrawals to "protect" investors.

The ongoing selloff in the Italian bank stocks continued apace, leading the nation's market regulators to ban short selling of shares of Banca Monte Paschi for three months. Italy's banks are burdened by €360 billion of non-performing loans, the equivalent of a fifth of the country's GDP. Collectively they have provisioned for only 45% of that amount. With shares sinking faster post-Brexit vote, there is building pressure for more bail-in funding for the system, and there were reports the government would set up a second fund - dubbed Atlante 2, with €3-5 billion in capital, after the Atlante fund set up earlier this year - to help clean up the mess.

The yuan weakened for the fifth week in a row, marking the longest losing streak for the Chinese currency this year. USD/CNY has risen to 6.6873, the yuan's weakest setting against the greenback since the first quarter of 2010. The June China FX report disclosed the biggest one-month gain in reserves in over 12 months, leading many participants to speculate that the PBoC has halted its regular FX market interventions and allowed the yuan to weaken in its quest to revive economic growth. The currency also saw its biggest weekly drop against a trade-weighted basket of 13 currencies in four weeks, another sign that Beijing has become tolerant of further declines. There was little hard data out this week - the Hong Kong PMI contracted for the 16th straight month in June as conditions deteriorated to their worst level since last summer - but speculation about PBoC rate cuts heated up and many analysts are saying another cycle of RRR cuts is in the offing in the second half of 2016.

The contagion of political uncertainty has infected another major economy, this time Australia. Last Sunday, Australians went to the polls to elect a new federal parliament, and almost a week later, Liberal/National Coalition and Labor remain basically deadlocked. The Australian Electoral Commission is recounting all ballots before announcing the official result, and as of Friday the conservative National Coalition is leading with 74 seats, followed by the Labor Party with 71, with the former ceding at least 16 seats to the latter. It appears that National Coalition will most likely be forming a government, but S&P lowered their outlook on Australia's AAA rating to negative from stable on Thursday as the lack of a strong mandate potentially dinged the future government's prospects for reining in the budget deficit.

Retailers reported much improved sales comps for the month of June. The Father's Day holiday on June 19, a calendar shift reporting the sales of Memorial Day weekend in June and good weather all contributed to boosting the month's business. Gap disclosed its first positive monthly comps report of 2016, with Old Navy posting a +5% comp. After flattish April and May SSS, L Brands posted an increase of 6%. The numbers may herald a third month of good total US retail sales (the June US retail sales report drops next Friday), after much better than expected April and May retail sales. However, many other retail comp sales reports remained deep in the red, with Zumiez, Buckle and Cosi reporting terrible numbers.