UK May Survives, Aussie Economy From Bad To Worse

The State of Affairs in Financial Markets — Jan 17

The flourishing risk in financial markets extends as the ES founds a new leg up, led by financials after banking giants the likes of Bank of America/Merrill Lynch or Goldman Sachs reported upbeat earnings even as volatility in its FICC business is an undesirable event. In the currency market, the short-term low vol means low-yielding carry trades more appealing, as reflected by the falls in the EUR or JPY against the Greenback. However, be no complacent as the macro risk profile structure originated thru Dec still casts a shadow.

Even as UK PM’s May managed to survive the no-confidence motion by Labour’s Jeremy Corbyn on Wednesday, backed by the full extent of her conservative party and the DUP, the muted volatility in the Sterling reminded us that this was the main scenario being discounted. Nonetheless, the bullish divergence in the UK vs US bond yield spreads, the pause in the flattening of the UK yield curve or the fact that we saw premiums to own GBP Calls in a temporality of 1-month above Puts*, suggesting that the risks towards the Sterling keep building towards further upside price discovery auctions.

*Update: In today’s 25-delta RR, Puts trade above Calls for the first time this week. Caution is warranted as option traders price in potential setback.

In what has arguably become the biggest mess in European history, neck to neck with the Greek debt crisis drama, UK’s PM next step has been to invite the opposition to begin negotiations. Everyone and his dogs is asking the same question. What’s next in the Brexit saga? What is May’s plan B?

In a nutshell, the clarity or lack thereof after the humiliating Brexit vote defeat takes us into the following stage: Extension of article 50 to delay the UK’s departure of the EU, softer Brexit or no Brexit. One of the options that appears to have been killed is the hard Brexit one as anyway you slice it, most seem to perceive that a hard Brexit and back to WTO rules would be catastrophic for the economy. As illustrated above, the UK yield curve or options pricing foretells us hard Brexit is largely priced out.

Morgan Stanley Research Team has put together a scenario tree with the different possibilities that exist after the Brexit vote defeat, noting that more clarity is expected by early February.

Source: Morgan Stanley

Moving into the European shared-currency, with a VIX back sub 20.00 this week — first time in a month — attracting short-term carry trade flows via EUR-funding and EU economic fundamentals in a state of disarray even, it’s been a real struggle to see any motion in the world’s most traded pair. ECB’s Draghi intervention in the European Parliament on Tuesday, highlighting the increasing downside risk that exist based on the weakening economic trend, harbingers theCB may be laying the grown for an adjustment in its economic projections and the market could be taking notice of it.

In the US, as the agonizing government shutdown extends into its 4th wee with no end in sight, the latest economic data justifies no celebrations either. This week’s Empire State Manuf was a reminder of the headwinds being faced in the manufacturing sector following the nationwide US ISM upset last month. The US PPI index also came worse-than-expected this week, and the pyrrhic pick up in the NAHB housing market to 58 vs a peak of 75 last year, is far from a meaningful positive to latch on.

Besides, we also learnt that the Beige Book, which is a summary of commentaries by Fed districts on current economic conditions, came surprisingly upbeat, which I personally find a lagging and out of whack with the reality to play out in Q1, that is, much slower growth courtesy of the slowdown in global economic activity taking its toll but most importantly, on the US government shutdown, which is expected to weaken domestic growth considerably during Q1. James Knightley Chief International Economist at ING, notes that risks for growth are moving to the downside quite rapidly as the longest shutdown in US history extends.

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The Daily Edge is authored by Ivan Delgado, Head of Market Research at Global Prime. The purpose of this content is to provide an assessment of the market conditions. The report takes an in-depth ...

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Peter Cooper 3 months ago Contributor's comment

No deal Brexit is dead in the water as it has to go back to parliament for approval via the mechanism of another no confidence vote (which would be lost this time), see:

seekingalpha.com/.../4234297-deal-brexit-will-never-pass-u-k-parliament

By default that makes a postponement of the Brexit inevitable as to hold an election or referendum or more negotiations will take months. However, the EU27 have to approve the reason for the extension so that takes us down to an election or referendum. Given that the government would likely be slaughtered in an election the referendum emerges as not only the least worst, but the only possible outcome. Buy £ but sell sterling assets as a high pound will hit stocks and house prices hard.

Bill Johnson 2 months ago Member's comment

Well said.