International Economy Archives — Page 22 of 27

What Does the Brexit Mean for the Fed and Interest Rates?

While the Brexit won’t actually take place until at least sometime next year, many investors and economists are concerned about the ramifications this will have on the global economy. The Federal Reserve is no exception. Prior to the vote, the Fed warned about the effects the Brexit might have, and since then has indicated it would hold off raising interest rates due to these risks. Markets now are giving almost no chance of a rate hike at next week’s meeting and, as shown in the chart above, there is still only a small chance of an increase in September or November. Both the futures market, which is used to calculate the odds above, and most economists give about a 50/50 chance of a hike in December. So while the Fed initially expected to raise interest rates four times in 2016, it seems now there’s a strong chance that there won’t be any.

Equity Returns Post Brexit

The United Kingdom’s (UK) vote to leave the European Union on June 23 was an unprecedented event that impacted markets across around the world. While this exit won’t actually take place for another two years, equities sold off in a knee-jerk fashion as investors feared the ramifications on the global economy. Due to the heavy exposure to Europe, non-U.S. developed markets suffered the most, losing nearly 10% before rebounding.

The United Kingdom’s vote to leave the European Union on June 23rd was an unprecedented event that impacted markets around the world. While this exit won’t actually take place for another two years, equities sold off in a knee-jerk fashion as investors feared the ramifications on the global economy. Due to the heavy exposure to Europe, non-U.S. developed markets suffered the most, losing nearly 10% before rebounding.

With the U.S. viewed as a safe haven, domestic equities have fared relatively well in the Brexit aftermath. The U.S. dollar appreciated following the decision while the British pound slumped to a 30 year low against the greenback. Emerging market (EM) currencies have also depreciated against the dollar however EM equities have been one of the stronger performers. This asset class has benefitted from the U.S. Federal Reserve indicating it will not make any significant interest rate movements due to the risk the Brexit poses to the economy. Only a few days after the UK vote, EM equities rallied for its biggest weekly gain since March. While the Brexit will undoubtedly have long-term ramifications, many of which are currently unclear, equity markets have rebounded from the initial sell-off.

BREXIT: The Results and What’s Next

June 2016

On June 23rd, the United Kingdom (UK) shocked markets with its vote to leave the European Union (EU). The Remain vote lost to the Leave vote, 48.1% to 51.9%, with a strong turnout throughout the UK. Younger voters sided with the Remain camp by a wide margin, while older voters supported the Leave camp (Exhibit 2). In the weeks leading up to the referendum, global equity/credit markets and the British pound experienced positive price movement in anticipation of a Remain verdict. Using polling information and odds makers as indicators, investors were caught off guard at the Brexit result, leading to dramatic losses for risk assets on June 24th.

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Predicting the Brexit Vote

Today – Thursday, June 23rd – is the long awaited date of the “Brexit” vote in which the United Kingdom will choose to with draw from or remain in the European Union. In the weeks leading up to today’s referendum, many polls indicated a very slim margin between the “remain” and “leave” votes, thus creating another layer of uncertainty within the financial markets.

Today – Thursday, June 23rd – is the long-awaited date of the “Brexit” vote in which the United Kingdom will choose to withdraw from or remain in the European Union. In the weeks leading up to today’s referendum, many polls indicated a very slim margin between the “remain” and “leave” votes, thus creating another layer of uncertainty within the financial markets.

However, recent market movements indicate that investors are betting on the “remain” campaign, led by Prime Minister David Cameron. As shown in this week’s chart, the pound/dollar exchange rate (blue line) was pushed toward a five-month high earlier this week. In fact, the sterling leapt the most since the Global Financial Crisis of 2008, and is already trading at levels that economists predicted it would reach after the referendum on Thursday. Additionally, European stocks reached their biggest three-day gain in almost 10 months erasing the UK’s benchmark index’s monthly decline.

Though the results of the Brexit vote will not be known until after markets close today, the above data combined with early market movements on Thursday indicate that the Brexit vote will fail and England will remain in the European Union. Should that expected result change, we can expect heightened volatility in the short term, with longer-term impacts on financial markets less clear at this point. As always, we will keep our clients abreast of market developments and potential portfolio ramifications.

What Should We Expect From an Oil Rebound?

Over the past 18 months oil has been a significant drag on global financial markets. While oil producing countries have obviously been hit the hardest, the rest of the world has also struggled. But recently there’s been a mild resurgence in oil, with the WTI index now near $50 per barrel.

Over the past 18 months, oil has been a significant drag on global financial markets. While oil producing countries have obviously been hit the hardest, the rest of the world has also struggled. But recently there’s been a mild resurgence in oil, with the WTI index now near $50 per barrel. This is still nowhere near its previous levels of over $100, but it is a significant increase from the low of about $26 seen earlier this year. This Chart of the Week examines what this means for different parts of the world by looking at the daily correlations between oil and MSCI countries’ indices over the past 18 months.

Not surprisingly, emerging markets, along with Canada, have the highest correlations due to their heavy dependence on oil exports. They’ve also had the worst performance over the past few years but stand to gain the most from rising oil prices. Developed markets though also have high correlations and even in the U.S. and Japan, which have the least significant correlations, oil is still a major factor. These correlations won’t necessarily hold up going forward, but the trend suggests that if oil continues its slow recovery financial markets will benefit across the board. While other issues may affect this recovery, such as a “Brexit” or Japan’s deflationary pressures, overall rising oil prices should be a boost to the global economy.

Can Brazil (Pole) Vault Its Way Out of a Floundering Economy?

While the Olympic Games certainly impact a host country’s balance sheet, what about their impact on the local stock market? What do local businesses have to gain from the massive influx of tourism spending and how can we expect this to impact Brazil for the coming games?

Charted above is the calendar year performance of a hosting country’s local stock market index for the year in which it hosted the summer games. Two outliers are noticeably apparent: South Korea during its dramatic economic growth period and China during the recent financial crisis. Omitting these given their extenuating economic circumstances, the average performance at year-end is about +12%. While this sample size is much too small from which conclusions can be derived, there may be validity to the thought that the short-term net economic impact of hosting the Olympics is a positive one.

Brazil is expecting an influx of 500,000 tourists for the games, and oftentimes a tourist visiting specifically for the Olympics is likely to spend more money than the typical tourist. For example, in London during the 2012 games, an Olympic-specific tourist spent £1,290 vs. £650 of the commonplace tourist. With Brazil in its worst recession since the 1930s, the country needs as much of the Olympic stimulus that it can get. Unfortunately, Brazil is facing a staggering number of hurdles blocking it from attracting the tourists it desires. Bad press surrounding the mistreatment of local citizens, the Zika virus hotbed, and an unfinished Olympic infrastructure may keep the big spenders away. Managing a successful experience for the athletes and at-home viewers, let alone extracting economic benefit from tourists, may require too much of a Herculean effort for the struggling country. Either way, though, the short-term stock returns from Brazil will reflect the success – or lack thereof – of the country’s Olympic hosting prowess.

UK: Should I Stay or Should I Go?

This week’s chart looks at polling information for the UK Referendum scheduled on June 23rd. On that day voters will decide whether or not to remain in the European Union.

This week’s chart looks at polling information for the UK Referendum scheduled on June 23rd. On that day voters will decide whether or not to remain in the European Union. Taking inspiration from last year’s “Grexit”, the market has appropriately named this potential event as the “Brexit.” The chart shows a Bloomberg composite indicator which takes an average of polling data from several surveys. The most recent results report 41% in favor of remaining, 40% in favor of leaving, and 19% undecided, suggesting a very close vote. The odds-makers, however, place the chance of the “Brexit” around 35%. In terms of economic consequences, it is hard to predict exactly what would happen should the “Brexit” occur, but in general, investors can expect to see a weaker pound, reduced business investment, and weaker economic growth with some spillover effects to the Eurozone. This is an event worth watching as it will likely have some influence on short-term market performance leading into the summer.

Moving Currencies

Currencies are a popular topic in investment circles today, as their impact on total returns can be meaningful for investors. While many investment funds do not hedge currency exposure at the portfolio level due to the costs involved and the expectation of mean reversion over time, certain market participants are very active in the foreign exchange markets and seek to capitalize on price movements among currencies, which can be volatile in the short-term. In this Chart of the Week, we look at carry trades, the fundamental strategy of market participants who speculate on currency movements. At its essence, a carry trade is borrowing money in a low-yielding currency and investing it in a high-yielding currency. At the close of the trade, the investor pockets the difference between the interest received on the higher yielding currency and the interest paid on the lower yielding currency (net of transaction costs).

This chart shows a collection of the top- and bottom-performing carry trades of 2015 and compares their returns with the year-to-date results of 2016. As the chart shows, speculating against the dollar generated severe losses for most currencies last year, as the dollar rallied throughout 2015. Many of the carry trades that lost against the U.S. dollar have seen positive gains through early March, but can the performance of these trades persist? On one hand, holding the U.S. dollar should remain beneficial as the currency is likely to show continued, albeit modest, strength vs. other major global currencies. Reasons for this include expectations of tightening by the Fed and diverging central bank policies. Even if the Fed does not raise rates for the rest of this year, it is unlikely that it would cut rates, so the supportive case for the U.S. dollar remains. The Euro, another major global currency, is contending with monetary easing from the European Central Bank. Furthermore, concerns over Euro-area growth and political tensions present a headwind for the currency.

On the other hand, emerging market currencies have shown strength thus far in 2016, as the turnaround in industrial metals prices elevated many commodity currencies, including the Brazilian real (BRL) and the Malaysian ringgit (MYR). Concerns over long-standing debt disputes in Argentina led to increased volatility for the Argentine peso (ARS) in recent years. The 2015 election of new President Mauricio Macri led to optimism over a deal with Argentina’s creditors, and the country reached an agreement with bondholders in early March. However, the country’s plan to raise new levels of debt in April caused a sharp downturn in its currency.

With the persistence of diverging central bank policies and the prospect of negative interest rates in many parts of the world, the outlook for many carry trades will continue to see meaningful impacts from macroeconomic volatility not only on a global level, but also on a country- and region-specific level.

Note: ARS=Argentine Peso; ISK=Iceland Krona; INR=Indian Rupee; BHD=Bahraini Dinar; JPY=Japanese Yen; EUR=Euro; DKK=Danish Krone; TRY=Turkish Lira; CLP=Chilean Peso; MXN=Mexican Peso; NOK=Norwegian Krone; CAD=Canadian Dollar; MYR=Malaysian Ringgit; ZAR=South African Rand; COP=Colombian Peso; BRL=Brazilian Real.

Is the U.S. on the Brink of a Recession?

The combination of rising high yield spreads and falling equity markets has led many investors to question if the U.S. is headed for a recession. This week’s chart examines the probability of a recession using the yield curve as a leading indicator of future economic activity. The Federal Reserve Bank of New York publishes a model that calculates the probability based on the difference (spread) between the 10-year and 3-month Treasury yields. As the spread narrows, the probability of a recession increases. Conversely, as the spread widens, the probability decreases. As the chart shows, this model has historically been a good predictor of future recessions. Based on January’s data there is only a 4.6% chance of a recession twelve months from now. Like all models, there are no guarantees that the predictive power will continue into the future, but this provides investors another tool to formulate future expectations.

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