Article 50 - Suspended Animation
Sterling was the big loser of the week falling another 3% on top of last week's more than 15% loss as it continued to reel after the Brexit referendum. Since the UK's historic vote, we have seen upheaval in the political arena and in financial markets. Prime Minister Cameron has resigned, an open revolt has occurred in the opposition Labour Party, the UK's sovereign rating has been downgraded from AAA to AA, and we have seen steep losses in UK, European, and US bank stocks.
The majority of the UK voted for Brexit – to leave the European Union (EU). However, it isn't so cut and dry. The UK government needs to invoke Article 50 of the Lisbon Treaty which lays out the ground work for a withdrawal from the EU. As it stands now, the outgoing Prime Minister has left it to his replacement, who may be in place by September. Of course, now there are rumblings of holding a new federal election before activating Article 50. Back pedaling? Perhaps, it wouldn't be the first time that the wishes of the people by way of referendum were completely ignored by its government. It has happened three times before in European referendums - Denmark on the Maastricht Treaty, Ireland on the Nice Treaty and Ireland again on the Lisbon Treaty. In each of these cases a second referendum was held which reversed the previous result. Will this happen again? The longer it goes without the activation of Article 50 the longer we stay in suspended animation.
As a side note, the popularity of the Trump Presidential run and the Brexit vote are one in the same. They are protest votes which began in 2010 in Tunisia. A Tunisian street vendor, Tarek el-Tayeb Mohamed Bouazizi, set himself on fire on 17th of December 2010, in protest of the confiscation of his wares and the harassment and humiliation that was inflicted on him by a municipal official and his aides. In short, he had enough of the police state of the dictatorship that he lived in. This not only set off a revolution in his own country, which brought down the country's dictator, but spurred on waves of protests in neighbouring countries known today as the Arab Spring. People domonstrated against absolute power in the form of dictatorships or monarchies, political corruption, economic decline, unemployment, and extreme poverty. Sound familiar - the wave of dissatisfied populous is growing and moving around the world and western countries are not immune. In the West, the chiasm between the 1% and the rest is growing, the offshoring of blue collar jobs via globalization, and the distaste for the status quo is hitting a fevered pitch.
Be that as it may, Brexit is not contained within the borders of the UK. Calls for referendum in the EU are being heard in Germany and France and the Czech President, Milos Zeman, went so far as to question not only the country's membership in the EU but in NATO as well. This of course will also put more pressure on the Eurozone and the euro. You wouldn't be able to decipher this by last week's half percent gain in the euro but don't be fooled – month end and quarter end flows masked the situation last week. Remember speculators move markets quickly and that's what transpired during the post Brexit trade. The real money will sustain the momentum and push the currency flows until the equity funds, corporations, and government entities rebalance their portfolios and balance sheets.
Bank of England Governor Mark Carney pulled a "Mario Draghi" out of his bag of tricks by pledging to do whatever the Bank must do to support Britain's economy. Several banks have already forecast that BOE will lower rates in July which is likely to take the GBP even lower. This will of course set off another round of monetary easing around the world – no other central banker can afford to let another take advantage by undercutting their domestic policy – thus, the "beggar thy neighbor" roundabout will continue. As for the Fed, traders are not looking for a rate hike until 2018 according to Fed fund futures. The market now believes there is only a 9% chance of a rate hike in 2016 and a 40.2% chance of a hike in 2017. Before the Brexit vote the market was pricing in a 76% chance of a quarter point hike by December 2016 – how quickly things change!
Where does that leave us? Well, with monetary easing as far as the eye can see and no interest rate hike from the Fed this leaves us with a risk on trade. You can see this in the all assets graphic which shows that the grey metals of silver, palladium, and platinum are leading the way higher. This is a classic risk on rally which has these metals distancing themselves from the traditional safe havens of gold, USD, and the Yen. Also, notice how the VIX, aka the fear index, is just melting away. Party on, until the next crisis.
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