Deja Vu.

16th June 2016

Ian Copelin, Investment Director, my wealth comments “Once again, the US Federal Reserve Bank (Fed), having talked up the prospects of an imminent US interest rise, backed-off.

Following the Fed’s April meeting officials started communicating that there was a strong probability of a June interest rate rise.  However, last night at the end of their 2 day Federal Open Market Committee (FOMC) meeting they had a completely different tone, indicating, as I have said a number of times in previous updates and newsletters, that it was unlikely the Fed would increase rates four times in 2016 – with six of the 17 officials now only seeing one increase this year!  While the US economy continues to create jobs and housing and construction continues to advance, wage growth and inflation remains low.  In addition, the Fed also slowed the pace of expected moves in 2017 and 2018 to 3 increases in both years from 4 increases.

In the UK, EU Referendum opinion polls published in the past week have suggested that Britain might vote to leave the EU.  While all the polls showed a different percentage-point lead, the momentum in opinion is currently with the ‘Leave’ campaign.

Anxiety heightened further on Tuesday when the UK’s best-selling newspaper, The Sun, backed the ‘Leave’ campaign.

Equity markets immediately reacted to this heightened uncertainty:  equity markets fell heavily with the FTSE-100 falling below 6,000 for the first time since February, and is currently trading around 5,930 – nearly 400 lower than the level it was trading at last week.

As a result demand for safe-havens, such as government bonds have done well.  The German 10-year government bond yield  has fallen below zero for the first time, meaning that investors who buy and hold the bond until it matures in 10 years will get less than what they paid for it!  Even the UK 10-year gilt yield has fallen to 1.1% – it was 2.3% this time last year and was as high as 1.65% just 7 weeks ago, on 26 April.

Furthermore, according to data compiled by Bloomberg, sterling is the world’s riskiest currency (measured by the magnitude of the pound’s price swings over 30 days).

While markets are positioning themselves according to the latest opinion poll, bookmakers (which did a better job at the last election than opinion polls) remain fairly confident that Britain will remain in the EU, with most betting firms and exchanges suggesting a 60% chance for a ‘Remain’ outcome.  Elsewhere, Morgan Stanley have this morning raised the probability of a ‘Brexit’ to 45% (i.e. 55% ‘Remain’) from 30%.

Their confidence is based on the fact that while the ‘Leave’ campaign isn’t exactly doing a great job at explaining what will happen to the UK if we leave the EU, the ‘Remain’ campaign, which is based on fear over the UK economy, is losing to the emotive subject of immigration and as a result, they expect voters to swing back to the status quo when they actually arrive at the ballot box.

I appreciate that the referendum media coverage and recent equity market weakness may be unsettling, but markets have already priced in a lot of uncertainty due to the recent polls.  Whilst equity market volatility is likely to continue in the run-up to next week’s vote, if, as we currently anticipate, the British public vote in favour of remaining in the EU there is likely to be a strong relief rally on 23 June.”