Demand for risk on central bank dovishness
Here we go again. A standing philosophy in our understanding of asset prices for the last 12 years has been that central bank’s policy is the dominant factor. The Fed and ECB have signaled a willingness to backstop risk with additional stimulus. Fed and ECB rate cuts are likely to come this summer. The market is now pricing in a 50% probability of a 10bp policy rate cut by the BoJ by year end. As expected the likely policy easing has further compressed risk premia allowing risk appetite to thrive. Equity markets have rallied in the wake of the dovish central bank (Norges Banks an exception). Some have been puzzled by the lack of market reactions to rising US and Iranian tensions. Investors shrugged off news of a U.S Navy drone shot down by Iran in international airspace. Crude oil prices were marginally higher as risk mounted at a critical gulf corridor for oil supplies. But the muted reaction is directly related to the central bank easing distorting the price of risk. With global yields coming down investors are hunting for returns regardless of the risk. Just look at the performance of the SMI. The enviable position solid dividends and CHF denomination have driven the equity index to record highs. Traders would not be bogged down in new flows but stay focused on the central bank’s policy.
Elsewhere, demand for the CHF and CHF asset has caused EURCHF to break below 1.11. According to SNB Chairman Jordon and every other member, the Swiss central bank stands ready to intervene on currency markets to rein in the strong franc. So where are they hiding? In a way, the SNB is faced with a similar backdrop as Jan 2015. With the ECB going more negative, capital will flee to Switzerland. But with a balance sheet already bloat its unclear how much firepower the SNB has. Trader have painful memories of dancing with the SNB and will tread lightly in this region.
Brexit: BoE pricing in best-case scenario
Not much surprised on the front of pound sterling. GBP benefitted from a short-lived gain as the Bank of England maintains its intention to raise interest rates while holding its bank rate unchanged at 0.75%. Although BoE Governor Carney confirmed an existing mismatch between the central bank optimistic scenario and financial markets’ alternatives concerning Brexit transition, we see confirmation that the BoE struggles to convince investors that an increase in borrowing costs is the right path to consider.
The BoE has been favoring a hawkish bias, raising interest rates two times since Brexit low of 0.25%. Yet uncertainties over Brexit have been limiting its room of maneuver. Elections of a new Prime Minister by Conservatives is becoming clearer, as the two candidates, former and current Foreign Secretary Boris Johnson and Jeremy Hunt, are participating to the final contest starting on the week beginning 22 July 2019. Whereas Jeremy Hunt owns a similar line to that of PM May, surveys tend to support Brexiteer Boris Johnson, increasing risks of a hard Brexit and acknowledging the view that short-term GBP gains should turn negative when BoE will be changing language towards a more neutral stance thereafter. Recent survey published by EY confirms that investor sentiment is declining in the country as half of the members of financial companies surveyed believe that the attractiveness of the United Kingdom will decrease in the next three years amid concerns relating to loss of EU markets access and labor mobility restrictions. Considering current events, we see little arguments in favor of a rate hike this year. May CPI has turned back to 2% (prior: 2.10%) and is less likely to accelerate in current economic environment. We recommend a bearish bias on GBP/USD in current settings.
