Brexit Drama Reaches Fever Pitch Following Death Of British MP

Even Jim Cramer admits it: global macro is in the driver’s seat.

On Friday morning the boisterous Mad Money host bemoaned the fact that no one seems to care about anything but Brexit and geopolitics. “I’m probably the only person in the world reading the Kroger quarter,” Cramer lamented. “It’s only the biggest grocery store chain in the country.”

Yes, that’s true. But when we’re facing the beginning of the end for the European Union, no one cares that same store sales (ex-fuel) grew 2.3% at a supermarket. Sorry Kroger.

It’s important to understand that this (the UK referendum) is perhaps a bigger deal now than it otherwise would be. It comes on the heels of last summer’s Greek tragicomedy after which parties sympathetic to the cause of the government in Athens gained sway in Portugal and Spain. Meanwhile, the influx of migrants from the war torn Mid-East has led directly to an exceptionally divisive environment within the EU’s core. In other words, the backlash against Brussels is coming from all sides. The periphery is restless about calls for further fiscal consolidation and many in the core are at their wit’s end with the refugee crisis. The fear is that a UK “leave” vote would open the door for more countries to exit. And make no mistake, an exit by a country that’s not only in the Schengen zone, but also in the euroarea (i.e. uses the EUR) would be a real mess. Here’s some color from Goldman:

“The tension continues to mount ahead of the Brexit referendum next Thursday. Our European economists’ forecasts continue to be based on the assumption that the UK votes to remain within the EU. But a potential Brexit would result in a negative growth shock to the UK economy, at least in the short term, with subsequent ramifications to the Euro area. It would also likely shift back the focus to the institutional weakness of the Euro area, potentially paring the recent CSPP stimulus in both the primary and secondary markets.”

Note that last sentence. What they’re saying is, Brexit would effectively offset the ECB’s corporate bond buying program (i.e. QE).

Just how much macro now matters was on full display late Thursday and on Friday. In what amounted to a reminder that markets are blind to political correctness and also to empathy, risk has rallied following the death of British MP Jo Cox who was stabbed and shot in broad daylight yesterday. Following the tragedy, referendum campaigns were suspended. That flashed a buy signal to markets as everyone suddenly began to wonder two things: 1) will there now be less support for the leave vote?, 2) will the vote go forward as planned? Here’s a bit from Reuters:

"We have lost a great star," the prime minister David Cameron said. "She was a great campaigning MP with huge compassion, with a big heart. It is dreadful, dreadful news."

It was not immediately clear what the impact would be on the June 23 referendum, which has polarized the nation into pro- and anti-EU camps. But some analysts speculated it could boost the pro-EU "Remain" campaign, which in recent days has fallen behind the "Leave" camp in opinion polls.

Yen strength abated, the pound firmed, oil rallied, and European stocks are up across the board.

But you’d be wise to remain cautious. This looks like a knee-jerk reaction. Actually, let’s rephrase: it is a knee-jerk reaction. You can expect risk-off to return with a vengeance starting Sunday evening when Asia kicks off the week. That is of course unless things take a dramatic turn in the UK over the weekend. Let’s take a look at how credit markets are behaving because don’t forget: when credit doesn’t agree with stocks, credit is usually right.

First, have a look at implied vol in iTraxx (so, the index of credit default swaps on euro corporates) versus CDX (the index of credit default swaps on US corporates):

(Chart: Goldman)

That despite the ECB bid.

Want to know how spooked the market is about near-term risk? Look no further than the vol term structure...

 

(Chart: Goldman)

… which is now inverted.
The read-through: synthetic credit sees troubled waters ahead. Watch the headlines coming out of the UK over the weekend for any signs that the “stay” vote has gained momentum in the wake of Thursday’s tragedy. If Cox’s death galvanizes public opinion against euroskeptics, that would be your risk-on greenlight.

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