Brexit anxiety returns with a vengeance

The negative sentiment was so pervasive that it was felt on Wall Street, across Europe, Asia and beyond. The Dow Jones Industrial Average shed 0.67%, the S&P 500 index lost 0.92% and the FTSE 100 index ended 1.86% lower. In Japan, the Nikkei 225 index plunged 0.40% and the Hang Seng dropped 1.20%. These are but a few of the many negative performances racked up on global equities markets.

Can Equities Markets Pass the Stress-Test in June?

Sentiment began to sour earlier in the week after a series of polls indicated a reversal in public opinion leading up to the Thursday, June 23 Brexit vote. The fear of a European Union without Britain is causing tremendous anxiety and markets, and traders do not react well to the uncertainty. High anxiety levels tend to drive traders towards safe-haven assets such as gold and government bonds. The global freefall on the yields of 10-year government bonds plunged in Japan, the United Kingdom and Germany. The bond market rally gained momentum on Thursday, 9 June, with decreased expectations of a June 15 rate hike weighing heavily on sentiment. The world’s biggest banks including Bank of America Merrill Lynch, Wells Fargo, Goldman Sachs and others came under fire last week as rate hikes appear unlikely. So pervasive was the bearish sentiment that the USD plunged to a 5-week low against the Japanese yen.
With so many traders choosing to lighten their equities portfolios in favour of lower yield bonds, the Japanese currency was a natural selection for traders. German 10-year Bunds also came into favour with investors given the extreme political uncertainty ahead of the vote on Thursday next week. The yield on 10-year Bunds dropped to 0.034%, then dropped further to 0.021%, hovering perilously close to negative territory. It should be pointed out that trillions of dollars’ worth of bonds around the world are already locked up in negative territory. In the United Kingdom, the 10-year Gilts are also trading at multiyear lows. Fueling the fire are concerns about the likelihood of a Brexit (British exit from the European Union). Wall Street found itself wrong-footed on Friday, with commodity prices like crude oil tumbling and the yield on government bonds dropping sharply.

Investors Rush into Bonds

There is widespread concern about two major events in June, including the FOMC meeting on June 14-15, and a week later the historic Brexit referendum in the United Kingdom on 23 June. It is generally expected that the Fed will not move this week, and this should be a positive for equities markets. However, concerns about a Brexit gained fresh momentum with a poll by The Independent which was released on Friday according to this poll, a sample size of 2000 Britons indicated that Britain should leave the EU by margin of 55% to 45%. With a poll this size and scope, and fresh momentum being built in favour of a Brexit, traders are naturally cautious. The yield on bonds is strongly correlated to the decision by Britons to leave the EU. The more bearish British public opinion is, the lower the yield on bonds. But there also concerns about the slowdown in global economic growth. In May 2016, nonfarm payrolls in the United States posted just 38,000 new jobs. While the Verizon strike was a rather big deal, the inclusion of those striking workers does little to bolster the confidence in the global economic slowdown.

Indices Across the Board on Retreat

The Fed will not be making any hasty decisions about raising interest rates given Brexit fears, negative interest rates in Japan and Europe, historically low yields on bonds and pervasive uncertainty in global markets. Indeed, Yellen indicated on Monday, 6 June in Philadelphia that an interest rate hike was coming but not quite yet. Government Bonds typically offer a far lower return on investment than equities, but the money is guaranteed. With yields on government bonds dropping across the board, the prices of those bonds rises all the time. The US 10-year treasury yield is now 1.649% – the lowest level since 11 February 2016. That fateful day was when markets in the US bottomed out for the year to date.
Even WTI crude oil could not sustain its rally and it plunged 3% to trade at $49.05 per barrel. This was partially brought about by news of an increased US rig count which means that oil supply is increasing once again. According to Baker Hughes, the number of US gas rigs and oil rigs hit 414 for the week ending Friday, 10 June 2016. This figure is 6 higher than a week ago. While nobody is calling for an end to investment in equities just yet, there is definitely a sense of backing away from equities at this time. Risk-averse investors across Europe have wasted no time pulling out of equities markets. The Euro Stoxx 50 closed at 2,911.11, down 2.61%, but it was the Spanish Ibex 35 which performed the worst with a 3.18% decline to close at 8,490.50. The French CAC 40 index closed at 4,306.72, down 2.24% and the German DAX closed at 9,834.62, down 2.52%.

Why Brexiteers are Gaining Ground

It is surprising that there has been a sharp reversal in public sentiment vis-à-vis the Brexit. However, a poll by the Observer indicates that 42% of those polled favour leaving the EU while 44% prefer to remain in the EU. But the real test of which way, Britain votes will be determined by the undecided voters on the day. On Friday last week, an estimated 1.5 million Britons had applied to vote in the last 7 days of the registration period. Germany is making plans to counter the effects of a potential Brexit, but there are concerns that other countries may follow suit. In the aftermath of all these polls, the GBP plunged 1.2% against the greenback and punters have the leave camp 10% ahead of the remain camp. According to the survey which polled 2000 people, Brexiteers were the majority with 55% and stay campaign people had a 45% advantage. Whatever the outcome, it is clear that the run-up to next week’s Brexit vote is going to have the GBP at its most volatile level in recent history. The world will be watching with baited breath.