Some thoughts on markets from RBC's Charlie McElligott
"CORRELATIONS GO TO ONE" ON BREXIT NAPALM
Pockets of risk are notably higher off the initial "shock" levels seen last night (i.e. GBP trading back to 1.388 last from 1.323 low / JPY to 103.1 last from 99.0 low / FTSE from -8.7 to now “just” -5.1% / SPX at worst -120 handles to 1999, now 2032 last), as tactical market participants front-run expected liquidity injections and interventions from CB's to either ‘dip buy’ for a trade, or sell into.
Nonetheless, the psychological damage overnight is simply jarring, and the long-term implications of the first domino in a potential "unwind" of globalization / shift to populism / protectionism / nationalism (see every nationalist right party calling for referendums throughout their respective countries in the EU) plays-out against a trading world lulled to sleep by the siren-song of "free carry," low vol and leverage. As stated last week, when people, goods and money are unable to move freely, it's a global growth negative, period.
Just...wow. The "left tail" scenario has played-out, and now, we are in the midst of a real-time "Minsky Moment" in Europe.
The UK has voted to leave the EU, shocking pollsters, book-makers, statisticians and--even just a handful of hours ago--the universal "market" embrace of an assumed "remain" scenario. I was part of that complacency. On account of this “all clear” view, many market participants had spent much of this past week "grossing back up."
The market carnage is staggering with regards to the violence seen in such a short period of time, as the stress and convexity of the move is exacerbated by the inability and unwillingness of market-makers to provide liquidity. There are few bodies capable of catching the falling knife right now, which has been the exact "unintended consequences" of post-crisis regulation that banks and brokers have warned about. Markets could SURE use that dealer balance sheet, prop desk or stat arb market-making book to mitigate such exaggerated price-action, i.e. JPY moving 450pips in about 7 seconds last night when it made absolute lows.
Moves of this magnitude are pure reads on "force outs"...that wasn't discretionary selling / covering, as NOBODY was positioned for this. The tide has "gone out"...and we are about to see who's been swimming naked.
It's "game over" for anybody out there who was short duration. CTA's / systematic trend strategies / managed futures funds / Crude and FX carry traders--all of whom exist on leverage--here comes "Mr Margin" calling on your risk longs. Obviously the "long cyclical beta" equities trade, which has been the basis of the recovery off the February lows, is about to come unglued when the US opens. Bank options dealer desks who by definition are "short volatility," as well as many clients who've made a living shorting vol in the post-GFC era as well--there are going to be some "lights out" stories making the rounds on huge losses...very scary stuff.
LARGEST OVERNIGHT MOVERS ON Z-SCORE BASIS: EU-centric obviously, but the drag-down implications of the Dollar move higher (see: crude and EMFX) are very troubling.
And don’t sleep on EU credit, where both SubFin and Xover are seeing 3.5+SD moves (SubFin just behind Lehman for all-time largest % one day move).
WHAT IS MOST “AT RISK”?: EU periphery equities (BANKS BANKS BANKS SX7E now -16.3% on day and 32.7% YTD, along w/ consumer discretionary), Eu peripheral Bonds (BTPs and Bonos), EU FX (Sterling resets to a new level in light of current acct deficit, Euro resets on existential risk uncertainty freezing the entire union economy), EMFX breakdown on USD move and leveraged deployed in space, and flight to safety in Yen and Franc crushing Japanese and Swiss exporters and thus local stock markets.
-WHERE DOES THE $ GO?: Gold and all things US—UST’s, USD, even US equities (not immediately of course, but eventually on relative basis) seeing enormous safe haven bid. "Low vol" / "anti-beta" market neutral / defensive sectors like utes, staples, telco and sleepy healthcare will obviously outperform against aforementioned cyclicals, beta, consumer discretionary and financials.
-WHAT MIGHT BE DIP-BUYABLE A LITTLE CLOSER TO THE “HOT ZONE”?: There will be support "at a price" on the ability for ECB to intervene in EU credit and periphery sovereigns (although CDS will u/p cash bonds)…but that is real “Kevlar gloves” trading with tight stops.
-RETURN OF THE DEFLATION TRADE: Dollar strength should be absolutely crushing for crude / commods / EM, as the deflation trade spectre rears its head again. Difficult to touch any of this stuff for a long time as I anticipate persistent weakness in Euro continuing to help strengthen the Dollar.
So is there any silver-lining here? Most likely, all the "bad news" is out there for now as we enter the haze of the article 50 / Lisbon Treaty "trigger" (3 month lag while PM Cameron transitions the government) and an ambiguous negotiated withdrawal that follows.
Now, we watch for "market stabilizing forces"--central banks, FX and pension rebalancers, corporates hedgers etc--to "do work." IT'S TIME TO BE AWARE OF UPSIDE "GAP RISK" NOW AS THESE PLAYERS ARE FORCED INTO ACTION. Even more obvious are the conditioned "dip buyers" who are already front-running the above inevitable action.
WHAT ARE NEXT MOVES / THOUGHTS / QUESTIONS?:
-BoE rate cut just a matter of time…
-Coordinated liquidity CB swap lines…
-Fed inability to act preemptively with a cut of their own as it's not a local issue. QE4 not relevant as rates have only plummeted lower. Tough spot for Yellen.
-What's the PBoC to do? Yuan fixes at weakest level against the Dollar since Jan ’11. Watch this.
-Govts intervening in FX mkts real-time, esp the Swiss National Bank, and EM's (south Korea, India and likely Singapore already), with risk of BoJ soon...
Welcome to your summer.