Sterling has a steadier day, but future still uncertain
UK markets had a semblance of stability yesterday as sterling licked its wounds after failing to break post-Brexit lows for the first time since the referendum. Although the UK currency and UK equities rose yesterday, both are far from erasing the sharp losses suffered since the vote. This is particularly evident in UK banking shares, some of the hardest hit in the sell-off from the past few days, where Barclays and RBS shares rose modestly but still have a circa 25% gap to reclaim before turning flat.
UK political quagmire far from over
It would be foolish to assume that this modicum of stability in FX markets means the worst is over – it’s perfectly natural for a protracted sell-off in any financial asset to pause for a breather before resuming a longer decline. The political quagmire in Westminster is going to do little to reassure sterling anytime soon, so the next cues for currency volatility are likely to come from the Bank of England who, if the UK experiences a protracted slowdown, could embark on new stimulus measures (rate cuts, QE) as soon as August this year and weaken the pound further.
Similarly in Europe, the euro looked slightly firmer yesterday, with European banking shares stabilising amid expectations of government support for Italian banks via their €40 billion bailout fund. Italian banks have been notorious for their lack of stability in the post-crisis Eurozone, so €40 billion should be seen as a plaster for a bullet wound as opposed to a panacea for Mediterranean finance.
Asian markets fare better as Japan expected to provide policy support
Globally, Asian markets have been far more effective at shrugging off the Brexit contagion, as Japanese and Chinese markets rose for the first time in three days. Japan has benefited from front-page rumours of further stimulus from the Bank of Japan and the Japanese government. Such a purchase program is well-worn ground for the Japanese and will do little to reassure investor confidence in a post-central bank intervention world. Nonetheless, the yen weakened against the US dollar, bringing the currency pair further away from the 100.00 danger zone.
US rate cut now seen as more likely than a rate hike
Brexit contagion is far from over, however. The US dollar has been a safe haven over the past few days, rising sharply against both the euro and sterling. It’s clear that this capital isn’t flowing into US equities but into bonds and treasuries, pressing their yields lower and forcing the market to now price in a 10% chance of a rate cut in November as opposed to a rate hike from the Federal Reserve.
Have a great day.