Who’s right? Given Referendums are only advisory in nature, and sovereignty rests with Parliament alone, the case had merit. And yesterday’s ruling in the High Court, the three ruling Judges agreed. The challengers maintain they are not contesting the referendum results, they just want legal process to be upheld. Others suspect the campaign is partisan, but even if so, the case still deserves to be heard. Parliamentary approval was required on the way in to Europe. It should be required on the way out. Rather than backing the down, the Government is taking the ruling to the Supreme Court in an attempt to get its way. By digging in deeper they are potentially compounding the error of not calling an election the moment that May was anointed Prime Minister. The fine line While in the summer the new Cabinet felt it was riding high on the momentum of populist support, there is a fine line between democracy and demagoguery. Had the Brexiteers had a clear plan for what happens next, there would not be a feeling of rushing headfirst into the unknown. As winter approaches, the need for a cool tempered defence of the sovereignty of Parliament is hard for even the most committed Brexiteers to deny: particularly as sovereignty was at the heart of the Leave campaign. Where’s the mandate? The Conservative government had the referendum in their electoral mandate. But not the mandate to act on its results. Nor did the country vote for May to be Prime Minister May. She should tread carefully. Borrowed time This leaves Prime Minister May with two unpalatable choices: Either to call a snap election (she should have done this when she won the leadership contest) to confirm her mandate as leader and the mandate to trigger Article 50 Or to try to brush the inconvenient constitutional truth of Parliamentary approval by taking it to the Supreme Court. Who’s afraid of an election? The new Cabinet is scared of an election. It could sweep them out of power and could push back further the decisive moment at which Article 50 is triggered as a new government reviews the position. The toxicity in Westminster between Conservative factions means that the political body count of MPs with reputations smashed or jobs lost will continue to grow. That is making the cabinet increasingly desperate. And desperate politicians make bad choices. Bottom line Chances are this Cabinet will fall apart before Article 50 gets triggered, either through extended legal wrangling in the Supreme Court (not a pretty site) or in an attempt to win a mandate by calling an election. With their parliamentary majority so slim, and the dramatis personae so different there is no guarantee they would win. [ENDS] NOTICES: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. This article has been written for a UK audience. For research purposes/market commentary only, does not constitute an investment recommendation or advice, and should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product. This blog reflects the views of the author and does not necessarily reflect the views of Elston Consulting, its clients or affiliates. For information and disclaimers, please see www.elstonconsulting.co.uk Image credit: clipart.co; Chart credit: N/A; Table credit: N/A October saw a sharp one month loss for global sovereigns owing to inflation fears, raised interest rate expectations and declining Central Bank appetite for QE.
In the US, prospects of a December Fed Rate hike saw 10 year yields clime 30bp on month and 76bp from summer lows to 1.26%, whilst stronger growth numbers raised inflation expectations and positive performance for TIPS. The USD performance for inflation-linked treasuries was -0.33% (LSE:ITPS), compared to for -1.32% (LON:IBTM) for conventional treasuries. In the EU, fears over the ECB’s commitment to QE contributed to the sell off. The EUR performance for inflation-linked Euro government bonds (LSE:IBCI) was -1.78%, compared to for -2.14% for conventional Euro government bonds (LSE:IEGA). In the UK, the inflationary potential from Brexit, and vanishing expectations of any further BoE rate cuts on stronger economic growth led to a gilts sell off. The GBP performance for inflation-linked gilts (LSE:INXG) was -0.65%, compared to -3.92% for (LSE:IGLT) for conventional gilts. Inflation The Bank of England has raised its 2017 inflation estimate to 2.7%, from the current rate of 1%. The Bank does not expect inflation to return to its 2% target until 2020. The rise in inflation expectations was explained by the decline in the pound since the EU referendum, which is driving up prices of imported goods. Fig 1. Projections for UK CPI based on market interest rate expectations Source: http://www.bankofengland.co.uk/publications/Pages/inflationreport/2016/nov.aspx Growth The economic growth rate forecast was also raised from 0.8% to 1.4% for 2017, whilst expectations were cut for 2018 from 1.8% to 1.5%, signalling that the Brexit impact will be felt later than originally expected. Further interest rates considered in August have been clearly ruled out. Fig 2. Projections for UK GDP based on market interest rate expectations Source: http://www.bankofengland.co.uk/publications/Pages/inflationreport/2016/nov.aspx
NOTICES: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. This article has been written for a US and UK audience. Tickers are shown for corresponding and/or similar ETFs prefixed by the relevant exchange code, e.g. “NYSEARCA:” (NYSE Arca Exchange) for US readers; “LON:” (London Stock Exchange) for UK readers. For research purposes/market commentary only, does not constitute an investment recommendation or advice, and should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product. This blog reflects the views of the author and does not necessarily reflect the views of Elston Consulting, its clients or affiliates. For information and disclaimers, please see www.elstonconsulting.co.uk Photo credit: N/A; Chart credit:Bank of England; Table credit: N/A
Give me a sign Just as high priests in Roman times, after slaughtering their offering, examined its entrails to gauge the Gods’ favour, so too have UK commentators been searching for any statistical insight or market data point to declare whether the shock Brexit result is likely to lead to economic success or failure. The data point phoney war The data that has come out since the EU Referendum on 23rd June 2016 is meaningless as we still don’t know what Brexit looks like. It’s been a phoney war for headlines, as stunned commentators search for a gauge to measure policymakers by. When politicians use statistics, it’s dangerous. When they co-opt data, it’s dynamite. First we had encouraging PMI Data. Brexiteers (those who want the UK to leave) read this as vindication, which is a stretch to any rational observer given the pace of transmission in the economy. Next we had Bremainers (Brits wanting the UK to remain in the EU) shouting “Pound Down/Told You So”, whilst Brexiteers shouting “Footsie Up/Told You So”. It took a while for pundits to figure out that both sides were right, because they were unknowingly saying the same thing. This is because the FTSE 100 (Footsie), consists of companies with predominantly overseas earnings. Hence the UK’s bell-weather index gains were more a function of the pound’s slide, rather than any inherent strength in the economy. Marmite makes it real But perhaps what has hit home hardest is the 24-hour Marmite price spatbetween two behemoths, Unilever (NYSEARCA:UN; LON:ULVR) and Tesco (LON:TSCO), which led to a tabloid induced panic. Marmite is the salty yeast-extract paste either loved or hated by Brits on their toast. Its main ingredient is the sludge left over from brewing beer, so it seemed odd that a UK product with UK input costs should be at risk from a price hike. But given Unilever’s equipment, cost of capital and investors are looking for Euro denominated returns, the impulse to raise prices was clear. So Unilever wanted to raise prices +10% to offset the -15% fall in the pound. Tesco, the UK’s largest grocery, with enlightened self-interest wanted to shield consumers and share the pain with their supplier. For the time being, retailers are shielding consumers from price rises. But that go on forever. The consumer pain from weaker currency will eventually be felt, and will have an inflationary impact. Where is Golidlocks? The true fear gauge for Brexit is therefore not currency alone, but currency and inflation expectations. UK inflation expectation are reflected in the market by the “breakeven rate” – the implied inflation rate derived from the difference between conventional and inflation-linked gilts of the same maturity. This is the UK’s “quiet fear gauge” for Brexit, as it is not referenced in the tabloids. On eve of Brexit vote, US & UK 5Y breakeven rate stood at 1.495% & 2.301% respectively. The lower level in the US reflecting their stronger and faster recovery, steering the US economy away from deflationary fears following the Global Financial Crisis. The UK has followed a broadly similar path since the Global Financial Crisis, albeit at a higher level. Chart 1: US and UK 5Y Breakeven Rates History Source: Bloomberg: USGGBE05 Index & UKGGBE05 Index, rebased 31-Dec-07=100 Whilst a long way from the Goldilocks dream of moderate growth with inflation that was ‘just right’, the chart shows that the big bad deflationary wolf of 2008 has been vanquished by the fairytale money created by Quantitative Easing, and inflation targeting is, broadly, back on track. For now. Hard Brexit is inflationary Since the UK’s EU Referendum on 23rd June 2016, relative inflation expectations have dramatically diverged. Whilst the US has notched up slightly to 1.584%, the UK has rocketed to 3.052%. Unhappily for the UK’s new Prime Minister Theresa May, the bulk of this uplift can be pinned to her ‘Hard Brexit’ reference in her speech at the Conservative Party Conference on 2nd October 2016. Chart 2: US and UK 5Y Breakeven Rates since UK’s EU Referendum Source: Bloomberg: USGGBE05 Index & UKGGBE05 Index, rebased 23-Jun-16=100
The logic for this is brutally consistent. Hard Brexit means harder trading conditions which means slower growth and weaker pound. Slower growth and rising inflation is a painful combination, and would prove a gruesome challenge for the Bank of England. Carney’s Mission Impossible? Whilst deflation loomed, and inflation remained subdued, the era of ultra-low or zero interest rates was a possible and necessary lever of support. If the Cabinet are hell-bent on hard Brexit, Governer Carney will face a near impossible mission: to defy gravity by keep rising inflation in check (around the 2% target) whilst propping up the economy (and the markets) with a 0.25% Base Rate. The Cabinet’s staunchest Brexiteers are still traumatised from ‘Project Fear’(when the machinery of Cameron’s government lined up behind “Remain”). There is therefore additional political risk if Carney’s apprehension at this impending challenge is construed as partisan, and his position is made – by coercion or insinuation – untenable. Personalities and emotions in the broken love triangle of Prime Minister, Chancellor and Governor will matter here. In that respect the venality of the post-Brexit reshuffle is not encouraging. Brexit: Hard or Soft? The referendum result was not expected. The change of the country’s and Conservative party’s leadership was not expected. The post-referendum realisation that Brexit would actually happen was not expected. The idea that the new Cabinet would go for a “hard” as opposed to “soft” Brexit takes the pain of this sequence of negative surprises to the limit. Wishful thinking would suggest that perhaps the Cabinet’s discussion of a hard Brexit is a cunning plan to fox our EU counterparts before negotiations start? Sadly, given the lack of preparation exhibited by the Brexiteers on their unexpected victory, that would ascribe too much credit, where none is due: whilst cunning was in abundance, there was no plan. Inflation-protecting a portfolio For US and UK portfolio investors, 1.5% and 3% respectively are now the hurdle rates if 5 year returns are to be ‘real’. For long-term multi-asset investors, it is worth considering how best to inflation protect each element of their portfolio
No clear plan Either a clear Remain vote, or a clear Leave vote with a prompt articulation of what Brexit means (the Norway model? the Turkish model? the Swiss model?) would have given UK markets the certainty investors crave. But now four months on, the Government is, it seems, simply making up what Brexit means as we go along, and trying to keep irreconcilable interest groups happy. There seems to be one message from the Government to Japanese car manufacturers, another to the City, another to the EU, and very little, of course, to the electorate: just that, with crypto-clarity “Brexit means Brexit”. A real fear gauge This lack of clarity and lack of direction is creating real economic costs, and will ultimately hit everyone in the pocket for more than just Marmite. The upward march of the UK breakeven rate is the fear gauge for that: watch it. NOTICES I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. This article has been written for a US and UK audience. Tickers are shown for corresponding and/or similar ETFs prefixed by the relevant exchange code, e.g. “NYSEARCA:” (NYSE Arca Exchange) for US readers; “LON:” (London Stock Exchange) for UK readers. For research purposes/market commentary only, does not constitute an investment recommendation or advice, and should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product. This blog reflects the views of the author and does not necessarily reflect the views of Elston Consulting, its clients or affiliates. For information on Elston’s research, products and services, please see www.elstonconsulting.co.uk Photo credit: Google Images; Chart credit: Bloomberg Professional; Table credit: N/A
Brexit it is The U.K. public has voted to leave the European Union after 43 years in yesterday's referendum. Leave has 51.7% of votes so far with 71.8% turnout (higher than previous general election) suggests a vote for Brexit by a narrow margin. The leaving process could take a minimum of two years, and even Leave campaigners don't expect the process to complete until 2020. Opinion polls were too close to call Polling pointed to a closer result and recent momentum for the Remain campaign which had given markets an element of (false) security: the final poll put 45% Leave, 44% Remain, 11% Don't Know. While the binary nature of the debate suggested that those undecided might abstain, turnout has been high at 72%, despite (you guessed it) bad weather. Source: BBC Article 50 The Prime Minister, David Cameron, must now decide whether invoke Article 50 of the Treaty of Lisbon (to leave the EU) which starts a 2-year exit negotiation process. If not invoked, there is potentially more time for negotiation, but it would create additional uncertainty, in terms of direction, timing and mandate. Experts ignored The Remain campaign was able to rely on the expertise of economists, business leaders, and international bodies such as the IMF, all warning of dire economic and security consequences under a Brexit scenario. The Leave camp, in rebellious vein, dismissed this as "project fear" being rolled out by a self-serving elite. Ultimately, the vote was as much about emotions as it was about argument. U.K. fragmentation One of the second-order risks that the Referendum has unleashed is the risk of the U.K. finding itself regionally split. At present, England is 53.2% Leave on 72.9% turnout and Wales is 52.5% Leave on 71.7% turnout. By contrast, Scotland is 62.0% Remain on 67.2% turnout, and Northern Ireland is 55.8% Remain on 62.9% turnout. One of the unintended consequences of a "Brexit" from the EU could be an independent Scotland remaining part of the EU. How Northern Ireland would be affected if it is outwith the EU with an open border with the Republic of Ireland that is within the EU is also going to require focus. Legend: Blue - Leave, Yellow - Remain
Source: BBC EU angst With the U.K. being the first country to leave the EU, a precedent will now be set. Remaining members of the bloc may also start to "think the unthinkable." Brexit will shake the foundations of the European project and trigger introspection in Brussels and, possibly, reform. Ironically, a reformed EU (focusing on trade only, without ambitions of statehood) is something that many Leave campaigners would want. But the vote suggests that expectations in the ability of the EU to reform are low. Markets Whereas a Remain vote would have enabled a business as usual relief rally, the Brexit vote means prolonged uncertainty as the U.K. attempts to shape what its future looks like outwith the EU. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article. Additional disclosure: This article has been written for a US and UK audience. Tickers are shown for corresponding and/or similar ETFs prefixed by the relevant exchange code, e.g. “NYSEARCA:” (NYSE Arca Exchange) for US readers; “LON:” (London Stock Exchange) for UK readers. For research purposes/market commentary only, does not constitute an investment recommendation or advice. For more information see www.elstonconsulting.co.uk Image credits: BBC Photo credit: George Hodan
The Japanese did it. The Europeans did it. Even the educated Swedes did it. So will the Fed ever lower interest rates below zero? Markets fell out of bed last week on fears the Fed might shift from a Zero-Interest Rate Policy ("ZIRP") that alleviated the pain of the financial crisis to a Negative Interest Rate Policy ("NIRP") to keep the monetary stimulus to the economy alive. Why does it matter The "feasibility study" being undertaken at this stage is a long way from a policy announcement, but would indicate a very different interest rate path to December's announcement. This volte face alone would query the Fed's credibility. Add to that the known unknown of how markets might operate in this Through the Looking Glass world where you pay to lend money to the lender of last resort, and some basic assumptions around the supply of, and return on, capital have to be adapted. How does it "work"? The short answer is: we'll see. In theory, by charging financial institutions to sit on surplus cash, they are forced to put that cash to work, for example lending to corporates to keep their wheels turning. In this way, negative rates act as a stimulus to the velocity of money, rather than the quantum of money supply. What are the issues? Issue number one is that it turns the fundamental relationship between providers and users of capital on its head. Aside from that are the legal and technical issues around how NIRP can be implemented in any jurisdiction. But, as we have seen so far - where there's a will there's a way. The sector most vulnerable is the banking sector as negative interest rates wreak havoc on Net Interest Margins - the spread between banks' borrowing and lending rates that is the cornerstone of their profitability. Hence the rather brutal round of price discovery that took place in the banking sector as a response to this new known unknown. From negative yields to negative rates Short-term real yields on government debt (i.e. nominal yields, adjusted for inflation) went negative in 2008 during the financial crisis. Short-term nominal yields on government bonds, issued by, for example, the US and Germany, have dipped in and out of negative territory thereafter, as a safety/fear trade signaling that those investors would rather pay governments to guarantee a return OF their capital, than demand corporates to promise a return ON their capital. So economically speaking, negative yields are not new. But what is new is that negative interest rates are being adopted as a central bank policy. How have markets reacted? Markets hates grappling with new concepts where there is no empirical data from the past on which to make hypotheses. Hence the "shock" increase in risk premia despite the ostensible further lowering of the cost of capital. Renewed interest in gold is the natural reflex for those scratching their head as monetary policy grows "curiouser and curiouser". What next? Central banks are adding NIRP to the armory of "unorthodox" levers at theirdisposal to achieve orthodox aims. To what extent this new weapon is deployed will depend on the underlying development in fundamentals around growth, jobless rates and inflation targeting. Those targets set the course to which monetary policy will steer. Whether the new policy levers have more efficacy than the old remains to be seen. Baked beans, anyone? The UK's baked bean price war of the mid 1990s, provides a parallel to the topsy turvey economics of negative pricing. To gain and retain customer market share, the big three British supermarkets slashed baked bean prices to around 10p a tin. Tesco's then broke ranks and slashed prices further to 3p a tin (subject to max 4 cans per customer per day). Not to be outdone by its bigger rivals, Chris Sanders of Sanders supermarket in Lympsham, Weston Super Mare made history by selling baked beans for MINUS Two Pence (subject to max 1 can per customer per day). Janet Yellen - you now know whom to call. While it didn't alter the fundamentals of the retail sector, it did mark the end of an irrational era of skewed economics. For the optimists out there, perhaps NIRP heralds the same? Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article. |
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