Janet Yellen trekked up Capitol Hill on Tuesday for her semi-annual Humphrey-Hawkins testimony. Frankly, it kind of feels like a snoozer. Here are some of the bullet points:
WE DO HAVE LEGAL BASIS TO PURSUE NEGATIVE RATES
NOT CONSIDERING NEGATIVE RATES
BREXIT-RELATED FINANCIAL VOLATILITY COULD AFFECT U.S.
I DON’T THINK RISKS TO FINANCIAL STABILITY ARE ELEVATED
WANT TO ENSURE ECONOMY ON GOOD PATH BEFORE RAISING RATE
WE’RE NOT RELYING MUCH ON FORWARD GUIDANCE NOW
REITERATES FED TO PROCEED CAUTIOUSLY IN RAISING RATES
The market heard everything it needed to hear from Yellen last week. The Fed is in no hurry to raise rates. All of the hawkish bluster in May was a head fake, the April Minutes meant exactly nothing, and although the Fed chair did emphasize that “one or two” data points shouldn’t be cause for anyone to change their long-term view of the nascent recovery, that appears to be precisely what the Fed did this month. If that’s not the case, then they at least used one data point (the May jobs number) to justify a dovish tilt that was in fact motivated by something else, which would be an even more inappropriate policy decision. Here’s a hint at what that “something else” might have been:
(Chart; Deutsche Bank)
As an equities trader, it’s important that you understand what’s driving the market. Right now, the world is embroiled in a currency war and increasingly, FX markets are where you’re seeing risk-on/ risk-off manifest. Clearly that’s not the only determinant of stock prices but it certainly is exerting a powerful push/pull on a daily basis. This has been amplified this week thanks to the looming UK referendum.
Let’s be clear: it’s not likely that the UK will vote to leave the EU. Note we said “not likely.” That doesn’t mean “can’t happen.” But it’s probably more black swan-ish (if you will) than the polls indicate. Generally speaking, the average person is more likely to stick with the status quo than risk venturing out into the great unknown especially when a whole chorus of notable figures are out warning about just how bad things would get should voters usher in a tail event. Here, for instance, is what George Soros wrote in an op-ed for The Guardian published Monday:
“The Bank of England, the Institute for Fiscal Studies and the IMF have assessed the long-term economic consequences of Brexit. They suggest an income loss of £3,000 to £5,000 annually per household – once the British economy settles down to its new steady-state five years or so after Brexit. But there are some more immediate financial consequences that have hardly been mentioned in the referendum debate.
“To start off, sterling is almost certain to fall steeply and quickly if there is a vote to leave– even more so after yesterday’s rebound as markets reacted to the shift in opinion polls towards remain. I would expect this devaluation to be bigger and more disruptive than the 15% devaluation that occurred in September 1992, when I was fortunate enough to make a substantial profit for my hedge fund investors, at the expense of the Bank of England and the British government.
“Today, there are speculative forces in the markets much bigger and more powerful. And they will be eager to exploit any miscalculations by the British government or British voters. A vote for Brexit would make some people very rich – but most voters considerably poorer.
I want people to know what the consequences of leaving the EU would be before they cast their votes, rather than after. A vote to leave could see the week end with a Black Friday, and serious consequences for ordinary people.”
Ok, then. Bad news. We get it. Here’s a graphic from Barclays who has endeavored to quantify the effect on global GDP growth:
(Chart: Barclays)
But don’t expect the average voter to necessarily listen to such warnings. The political environment in Europe is highly polarized amid the continuing flow of refugees from the war torn Mid-East and the persistent threat of terror. The pro-leave contingent can play on those fears and if there’s anything that strikes a chord with voters more than an appeal to their wallets, it’s an appeal to their safety. So “Brexit” may be unlikely, but it’s not far-fetched, per se.
So here’s the thing you need to watch: as Soros alluded to, sterling has rallied hard…
But the yen which, given Monday’s big Nikkei rally and palpable risk-on sentiment, should have probably tested 105, well, didn’t…
Consider the following from Bloomberg’s Richard Breslow:
“Yesterday, the markets leapt with joy as expectations took a decided turn about the EU referendum. Risk was on. No one needed any stinkin’ safe havens anymore. So I couldn’t help picturing Bank of Japan staffers staring at their screens and complaining, ‘What are we, wood?’”
“If there was one conspicuous piece of the narrative that was missing, it was the yen weakening. Especially as the Nikkei flew higher to levels not seen since last week. At its highest level of the day, USD/JPY didn’t even make a serious attempt to retake the 105 level.”
So why should you care as a US equities trader? Well, because this sets the stage for an even more violent reversal in the event there’s a surprise on Thursday.
If the UK does happen to vote for a Brexit, there’s even further for cable to fall now than there was previously and because the yen didn’t weaken in tandem with the strength in risk assets on Monday, there’s even greater potential for the Japanese currency to push towards 100 and that, as we’ve seen, would be very bad news for US stocks. Throw in the fact that the risk-off sentiment would be quite acute, and you have the perfect setup for, as Soros puts it, “Black Friday.”
Does this mean you should be a gambler and try to get rich betting the house on a Friday collapse and a soaring yen? Probably not. But it might be wise to go into this vote neutral.
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