The Black Swan Landed: What Happens Now?

Ok, the Brexit dust has settled. Sort of, although there’s a Russell rebalance today, so don’t forget about that.

The obvious question going into the weekend is this: “so by almost all accounts that was a

catastrophe, what now?”

Well, the first thing you should probably take into consideration is the collective central bank reaction. First off, they’ll move to ensure there’s not a major funding crunch. The Fed was out this morning reassuring the market that dollar liquidity is readily available. Here’s BofAML:

“The first order response by most central banks has and will likely focus on preventing a funding crisis. In this regard, the key will be the usage of the Fed’s dollar swap lines.”

“At the height of the financial crisis, usage of the Fed’s USD facility reached $583 billion, however, this has only seen periodic use since 2010 (most notably during the European sovereign crisis in 2012). Usage of the facility increased as the cost of the swap lines was reduced from OIS + 100bps to the current fee of OIS + 50bps in late November 2011. Currently, the relative attractiveness of tapping the USD swap lines has increased and suggests that if current conditions persist or tighten further swap line usage may rise.”

(Chart: BofAML)

You’ll likely also get a BoE rate cut (possibly to zero) and fresh QE (BofAML’s prediction is an expansion of  £50bn). Citi isn’t so sure. “We think they wait to assess the impact on economy,” the bank said today.

As for the Fed, one certainly imagines they’ll be even more cautious now with regard to the timing of the next hike. After all, Yellen herself said the Brexit vote “factored in” to the June decision. For their part, JPMorgan has pushed out their call for the next hike to December from September citing “exceptionally low visibility on the monetary policy outlook.” Here’s a look at Fed Funds futs (December and September):

As for Japan, you might want to watch for a “yen”-tervention, so to speak. We’ve been warning of this for some time, but the country’s flagging economy simply can’t take much more of this:

“Japanese intervention to stem JPY strength seems probable,” Citi says, before warning that “it may be an error to intervene before [more clarity is available] because the intervention itself does little to reverse safe-haven demand, it simply provides better entry levels to buy.” Here’s a bit more color on the BoJ’s options (or lack thereof) from Goldman:

“Japanese authorities would be inclined to seek G7 coordinated intervention in the foreign exchange market to prevent further JPY appreciation, but visibility is very low because this is not necessarily a mutually shared interest with others. We also believe that an uncoordinated solo intervention by Japan would be a difficult policy option to take, as the effectiveness of such intervention would likely be limited amid a possible backlash from other nations.”

Finally, here’s a look at the path ahead politically for the UK:

(Chart: Citi)

As far as equities go, you may want to exercise caution here. Have a look at a YTD chart of the S&P:

We’re still some 12% off the lows!

We’ll close with some advice from Bloomberg’s Richard Breslow which you can ponder over the weekend:

“Volatility is scary because central banks have tried to distort it out of existence. But the truth is, this is going to be a traders’ market. You don’t have to do size, just be active. How rare it’s been to have multiple opportunity days.”

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1 Comment

  • Ted

    June 24, 2016

    heisenberg! i love all of your reports. keep up the fantastic work. theo traders have such an under-rated, content-rich resource here!

    anyway, how long until US traders follow Japan and start calling BS on QE, rate cuts and CB intervention??? Next time Yellen comes out with a rate cut, the market should tank -- as it should --- the prop job is so transparent -- who really believes any of this is helping anything but expand a HUGE debt bubble???

    peace
    ted