Game Over for the Fed - Derivative Logic

Last Week: To say the BREXIT vote made for a lively end to the week is an understatement, though markets regained some composure from the early panic as markets made up some of the initial, knee-jerk losses. The 10-year Treasury traded 13bps lower to 1.5599%, while 1-month LIBOR declined 27bps to .4493%.

This Week: US economic data releases are a side show at the moment as the market focuses completely on the impact of BREXIT on both the US and the world. While data on the calendar is important, it’s not important enough to make an impression against the dominant BREXIT story.

Data on international trade, business inflation, manufacturing, Q1 GDP, consumer confidence consumer services, personal income and home sales are largely expected to show an economy that continues slow but steady growth, with generally all important economic gauges improving.

Take Away:

Game Over for the Fed: It’s likely game over for any Fed hikes, certainly this year, and depending on the way the shock plays out, potentially through Q1 2017. With at least a two-year UK-exit negotiation process hanging over markets, Yellen & Co. will likely maintain a “wait and see” mode as the macro impact slowly becomes clearer.
Even Lower for Longer: Global central banks will all lean toward cautionary policies, and yields will become even lower (and perhaps more negative in places) than they already are. As yields dip lower, investors search for it will grow ever more, making US Treasuries even more popular as the only yield in town. As a result, prices for Treasuries will trade higher while exerting downward pressure on US yields.
Slow Burn: While a shock, the BREXIT vote it kicks off a lengthy, multi-year divorce negotiation crawl. Its impact however, will be felt as more of a slow burn rather than sudden, multi-event Lehman-like shock. This should give markets and policymakers more time to absorb its impact, limiting frequent bouts of excessive movements in asset prices.
Watch for Contagion: The BREXIT vote is the most dramatic event in what could be a long process of political fragmentation in the EU. Emboldened euroskeptic parties across Europe could present Britain as an example to follow and, depending on the depth of the economic impact on the UK, other countries could come under pressure to make similar EU-exit proposals. One of the most critical countries to watch is France, which faces elections in 2017 and whose main Euroskeptic party has already called for a similar exit vote. The more France drifts from the EU core, the faster the foundation of the European Union crumbles, the greater the global economic uncertainty and the greater the odds of a “lower interest rates for longer” global scenario.

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