A look at the S&P 500 in the aftermath of Brexit might suggest that this historic occurrence was as fleeting ultimately as the market spasms associated with the 2013 taper tantrum and, more recently, fears about the Chinese economy.
Clearly, risk assets have rebounded in spectacular fashion since their initial post-vote downturn, but it took the clear support of central banks to make that happen, including reduced bank capital requirements in the U.K., commitment to QE by the ECB, and a backstop of the Federal Reserve’s attention to global events in setting policy.
Whether that sort of support makes this less than a “real” market recovery is a question. Part of the issue with Brexit is that so much is uncertain—the timing of notice to the ECB, the terms of separation, the nature of Britain’s economic ties in its aftermath. The downsides come from businesses hamstrung by an information vacuum and potential “voting” by companies to leave or at least reduce their presence in Britain. The U.K. will take an economic hit, the EU a more modest one, but other economies could be affected as well.
Will Discontent Spread?
There is, of course, the underlying question of whether the discontent expressed in the Brexit vote will find voice elsewhere. The twin lightning rods of trade and immigration in our view are really just outgrowths of reduced opportunity, and I believe governments will need to work harder on fiscal measures and structural reforms to alleviate current ills.
Importantly, currency markets have generally held onto post-Brexit moves, with the sterling faring the worst—an inflationary influence that complicates the task of the Bank of England—while yen strength creates a challenge for growth-hungry Japan. Sovereign yields, meanwhile, have moved lower, and given all the current monetary support, seem unlikely to work their way up significantly just yet.post-Brexit moves, with the sterling faring the worst—an inflationary influence that complicates the task of the Bank of England—while yen strength creates a challenge for growth-hungry Japan. Sovereign yields, meanwhile, have moved lower, and given all the current monetary support, seem unlikely to work their way up significantly just yet.
Declining Rate Expectations—Fed ‘Dots’ and the Market
Source: Federal Reserve, CME, Bloomberg, Neuberger Berman calculations.
All of this leads to the question of where bonds can go from here. I’ve been talking about the end of the fixed income bull market for years now. And every time I think that we’ve reached an inflection point, something else happens to push the yield bar lower—in this case the Brexit surprise.
Long-Term Slide of Bond Yields 10-Year Government Yields Across Developed Markets
Source: Bloomberg, data through July 1, 2016.
If it’s any comfort (and really it should be for any fans of economic stability), I think we are getting closer to a turn and a potential reversal of some of the recent gains we’ve witnessed. The crux, of course, will be to have a clearer trajectory for growth in the Eurozone that can help reverse the persistent downward bias in inflation expectations, which have been so difficult for central banks to undo.
For now, technical conditions remain quite favorable for bonds, particularly in the U.S. where so much global money is gravitating. So, hats off to Brexit, which seems to have extended this historic rates boom, even if only for a bit longer.
Midyear Outlook – Key TakeawaysEnvironment
Rates and Sectors
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