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Brexit out of control; Fed backstops risk

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Brexit out of control

By Arnaud Masset

After the UK Parliament took control of Brexit on Monday, the pound sterling stabilised at around USD 1.32, showing that all options remain on the table. Investors are buying short-term protection against a depreciation of the pound: 1-week implied volatility rose to 16%, while the 25-delta risk reversal measure eased to -1.44% from -0.30 a week ago. In equity markets, reaction was similar with the Footsie edging up 0.02%. Overall, the UK outlook has barely changed: Brexit needs to be addressed!

Prime Minister Theresa May lost control of Brexit on Monday, when Parliament voted (329 versus 302) to grant itself votes on a series of alternative solutions, ranging from leaving without a deal to holding a second referendum. Given that most parliamentarians are in the “remain” camp, the worst that can happen is a soft Brexit. We won’t be surprised if Parliament pushes for a second referendum. It wouldn’t be the first time that a country’s initial decision about the EU is not respected (see France’s and Netherland’s rejection of the EU constitutional treaty in 2005).

Fed Backstops Risk

By Peter Rosenstreich

To watchers of the US Federal Reserve, the biggest surprise lately was an announcement to end balance sheet reduction in September. This should keep assets near USD3.5 trillion, significantly higher than previously indicated. The Fed is also reducing the cap on US treasuries allowed to mature each month from USD30 billion to USD215 billion in May. Anxieties about a scarcity of reserves in the banking system are the driver. Regulatory shifts since the financial crisis demand banks to maintain safe capital that can be used in case of an economic shock. This has increased the demand for “safe” US T-bills. Interest rates may have peaked: this should put a floor on US equities.

The US domestic economy has failed to generate inflation above the Fed’s 2% target. The risk of a pre-emptive hike would be to push the USD higher and further slow economic activity. The Fed has downgraded its economic growth estimate. GDP growth was lowered for 2019 to 2.10% from a previous estimate of 2.3%. Unemployment is forecast to rise to 3.7% in 2019 against 3.5% at the December 2018 meeting. The Fed’s median for inflation is set at 1.8% in 2019 and 1.9% in 2020 and 2021.

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Source: https://en.swissquote.com/
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