As David Cameron returned from his first summit in Brussels after the EU membership referendum in the UK, markets looked to have stabilised in the course of the trading day on 29 June. Indeed, the FTSE 100 seemed to have made up much of the shock losses it had sustained immediately after the result last Friday, closing at 6360. The S&P 500 was back in positive territory for the year at the close in New York (2070), and oil was close to $50/bbl. Business as usual then?
Not so, according to some analysts, who cautioned that traders and investors may be lulled into a false sense of security. Jane Foley, senior currency strategist at Rabobank, told the Financial Times that “there is a risk that investors are currently at risk of failing to face up to the political and economic issues that now confront the UK.”
Sense Of Security?
While the market has been assured by expectations of further easing by a range of central banks, traders should not be seeing this as a cure all for the market’s woes. For starters, the UK government and opposition are both in disarray, and confidence in the UK economy has been further eroded by downgrades from the big ratings agencies. It should also be noted that the FTSE 250, which is regarded as a better benchmark of the UK equities market than the FTSE 100, is still underwater to the tune of over 7%. Don’t let the big stocks on the main index fool you into a false sense of security.
Volatility does seem to be temporarily leaving the markets, but many unresolved political and economic questions remain, surrounding not only Brexit itself, but the future of the European Union. Markets will not like the high levels of uncertainty we are now seeing, and we don’t see them receding anytime soon.
Michael Hewson, senior analyst at CMC Markets, was sanguine about the immediate threat of the downgrades from the ratings agencies: “In reality these downgrades tend to matter less now than they did prior to the financial crisis, given that the UK has an independent central bank and can print its own currency,” he explained.
He also added that the fact that UK banks have been summoned to the Bank of England to encourage them to keep lending channels open seems also to have reassured the market.
Chris Weston, a market analyst with IG, sounded a note of caution to those who might be relaxing in front of their trading screens today: “The UK referendum has reminded traders how violently markets can react when a known event goes completely against expectations, with market participants positioned for a singular outcome,” he said. “It taught traders about how markets react when participants are largely unschooled in political effects and the knock on effects of political movements plays into economics, confidence and the final perception of a final central bank response.”
He pointed to the fact that there are a number of political events in Europe and the US ahead of us in the next 12 months, with the UK setting a precedent for some other EU members who are seeing a rise in anti-EU sentiment internally, not least France and Spain.
“If Greece caused massive bouts of volatility in periods through the last five years then the political event risk in front of us over the next 15 months could make the volatility recently seen look fairly sanguine,” he added.
Gold seemed to be consolidating slightly north of $1300 yesterday, with some analysts identifying this as a fairly obvious support level, while markets took a small breather. However, there seems to be a consensus that there will be more gold buying ahead as political uncertainty in Europe this summer coupled with negative bond yields continues to frighten investors.
At LCG, analyst Ipek Ozkardeskaya said that potential contagion effects from Brexit, coupled with a softer Fed, “could encourage a mid-term rise to $1400.”
We are by no means out of the woods. Brexit is just the match lighting the touch paper for more fireworks to come. Going into this vote, the global economy was far from in good shape, particularly with a slowdown in China and potential problems in that country’s lending markets. Other major drivers of growth from the developing world, like Brazil and India, have failed to show up. Many of the systemic problems within the financial system that regulation was meant to have resolved post-2009 are still lurking there. Banks may be in better shape than they were in 2008, but many traders now worry about liquidity in the markets.
As many spread betting and CFD brokers announced that margins would be reverting to normal levels in the course of this week, we would advise traders to maintain some enhanced margin discipline of their own, as further political shocks in the weeks and months ahead could hit liquidity levels. It’s going to be an interesting ride.