Should We be Worried About Post-Brexit Uncertainty

2016, Issue VI:  Should We be Worried About Post-Brexit Uncertainty 

Key themes[1]

§  First, US Fed timeline for eventual future rate hike remains data dependent. US growth recovery remains on track but recent global developments out of China and enhanced volatile market activity due to Brexit may potentially affect the number of hikes in 2016. Generally expect USD to be more mildly positive now.  We are now not expecting a hike in 2016 and at most 1 hike in 4Q at the most. Key US events: ISM Manufacturing Mar (1 Jul) (expected: 51.4); Factory Orders (5 Jul); June FOMC minutes release (7 Jul); US Beige Book (14 Jul); US May NFP (8 Jul) (expected: 180k); CPI (15 Jul); GDP 2Q (29 Jul); FOMC decision (28 Jul). Fed Lockhart speaks in Idaho (14 Jul); Fed George speaks in Oklahoma City (15 Jul).

§  Second, Japan’s 2% inflation target has been pushed back to 2H FY 2017 (by Mar 2018) due to oil softness and slow traction in wage increases. The credibility of Abenomics has waned somewhat in 2016 even though the easing bias is still clear.  We do not expect any further moves by the BOJ until Jul meeting at the earliest  and further jawboning is likely until then. Postponement of the consumption sales tax hike to Oct 2019 is now very likely, removing a likely drag on the economy. BOJ meets on 29 Jul to decide on policy. CPI (29 Jul)There is also the final print of 1Q 2016 GDP due on 8 Jun. JGB auctions in Jun: 10-year (5 Jul), 30-year (12 Jul), 5-year (14 Jul), 1-year (15 Jul) and 20-year (20 Jul).

§  Third,  post-Brexit, odds are rising for ECB to cut rate by another 10bps, but we think it remains too early to tell. To be sure, Brexit creates EU contagion risks. It is likely to see more Far Right parties within the Euro-group (in Spain, Italy, France) to call for “Leave EU” referendums. The second order effects of a Brexit on the future of the Euro-club could be further undermined and this could further heighten market volatility and trigger risk-off sentiment in the short term. EUR is likely to remain under pressure towards 1.07-1.08 levels. We expect ECB to monitor market development, assess impact of the UK-fallout and not take hasty action remain while still adopting an easing bias at the upcoming meeting (21 Jul). We believe ECB stands ready to provide additional liquidity measures, when necessary. Data/Events we are watching for the month ahead includes Jun CPI (15 Jul); Jul ZEW survey (19 Jul); ECB meeting (21 Jul); Jul Flash PMIs out of Eurozone (22 Jul) and Euro-area Jul confidence data (28 Jul).

§  Fourth, China still has excess capacity, heavily indebted corporations and huge liquidity injections continue to add immense pressure on the economy and the yuan medium term. PBOC continues to rely on SLF, MLF and PSL  as liquidity tools, we do not rule out interest rate cut of 25bps and RRR to be cut in intervals by another 100bps in the second half of the year. 2Q GDP and activity indicators (i.e. urban investments, industrial production and retail sales) will be eyed on the 15th. Jun PMI-mfg is due on 1 Jul along with Caixin version. Foreign reserves is scheduled for release on the 7th. CPI and PPI on the 10th.  Liquidity numbers are due from 10th-15th.  We also eye potential inclusion into MSCI and JPM bond indexes.

§  We could see some USD support as cautious risk sentiments may linger post Brexit. In the lead up to Jul/Sep/Dec FoMC, USD could be more supported  against the majors (i.e. GBP and EUR) than against AXJs. High yield plays may emerge, lending support to AXJs (IDR and MYR) and antipodeans.

^[1] Underlined words represent new developments in the FX themes.

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[1] Italicised and underlined words represent new developments in the FX themes.