Brexit, Brazil and BoJ Dominate Markets

Thursday May 12: Five things the markets are talking about

Foreign exchange markets are expected to remain quiet until Friday when the U.S. is scheduled to release retail sales figures, key economic data that should trigger movement among the major currency pairs.

However, sterling could be the exception, albeit for a brief period this morning, as today is “Super Thursday” for the Bank of England (BoE).

Brexit Investors will get the latest monetary policy decision, the minutes from the meeting, the latest inflation report and also get to hear from Governor Carney in a few hours.

1. Brexit governs Carney’s agenda

The market will be focusing on the BoE’s rate decision to see whether Brexit risk turns any MPC members into doves.

Expect BoE’s Governor Carney to be walking a fine line today, hoping not to upset or provide support for either side of the Brexit debate when he will be communicating the economic impacts of a Brexit and the implications for monetary policy.

With just six weeks to go until Britain’s referendum on its European Union membership, the Governor has already warned that uncertainty may be weighing on growth.

Already, Brexit jitters are taking a toll on demand. U.K services, the biggest part of the their economy, fell to its lowest level in more than three years last month. While recent manufacturing and industrial production prints have also fallen short of expectations.

Rates are not expected to change, but one or two of the nine-member MPC team may vote for further easing as Brexit worries turn them into doves – this will provide Sterling and U.K bond market volatility.

2. Brazil’s Rousseff suspended

Brazil’s Senate voted to suspend President Rousseff from office to face an impeachment trial earlier this morning after a marathon session. A new government will now take command of Latin America’s largest economy. Senators voted 55 against 22 to open impeachment trial.

Brazil’s impeachment process is lengthy and complicated. Rousseff will now have to step down and stand trial in the Senate, in a process that could by law last as long as six-months and result in her permanent removal from office.

Analysts are expecting an acting government to assume a more “investor-friendly” agenda, but do believe that asset-price impact to be limited as the change in power has been well transmitted.

3. The BoJ remains verbally active

Yen has managed to drift away from its 18-month outright dollar low (¥105.57) print from last week, supported by “official” Japanese government rhetoric over the past few sessions. The verbal intervention has managed to weaken the yen (¥109.18) somewhat, a very overcrowded trade.

The BoJ has now taken up the baton with Governor Kuroda stating that the central banks “can still ease monetary policy substantially” if necessary. Kuroda said the effects of quantitative and qualitative easing, or QQE, along with a negative interest rate are “already very clear” in financial markets, but “we have to wait a few months to see the effects in the real economy.”

Mr. Kuroda said that the recent strength in the yen is not the result of BoJ policy, but the uncertainty about China’s economy, weak oil prices and reduced expectations for interest-rate increases from Fed has led to the yen’s appreciation. He believes that the “external factors are starting to stabilize.” If he is correct, yen bear positions will begin to pay off.

4. Norway’s Central Bank remains on hold

Earlier this morning Norway’s Central Bank (Norges) left its deposit rates unchanged as expected at +0.50%.

Norges policy statement noted that it did not consider a cut, but to follow “the same game plan” from March. Analysts note that overall development had not deviated much over the past seven week’s. Inflation remained elevated, but NOK’s (€9.2531) strength might contribute to more rapid decrease in inflation.

Official’s suggested that the recent uptick in oil price increase could reduce uncertainty and contribute to higher economic growth. Governor Olsen did note that NOK had appreciated and is stronger than envisioned compared to their March forecasts. Both monetary policy and fiscal policy were taken into consideration in their decision.

5. European borrowers continue to go long

Yield curves continue to flatten. Why? As investors search for returns, higher-yielding bonds with longer maturities have become more popular. This shift has occurred mostly on the back of the ECB’s stimulus measures having pushed down bond yields and lowered borrowing costs across region.

Companies are happy borrowing at longer maturities, lower rates allows them to lock in “cheap” funding over time.

Already this week, the Spanish government went to market with 50-year bonds for the first time and Ireland issued 100-year bonds a few weeks ago.

Borrower’s love cheap funding, but for the investor, long dated products, despite offering the prospect of positive returns, are more exposed to sudden changes in interest rates (yields and price have an inverse relationship).

Yesterday’s strong U.S 10-year auction demand would suggest that investors’ remain cautious on the outlook on global growth and inflation outlook, especially with U.S stocks near record highs and oil hitting 2016 highs.

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