Morning Report: Implications of Brexit 6/27/16

Stocks are lower this morning as markets adjust to Brexit. Bonds and MBS are up.

Here is the summary of the financial market reaction to Brexit: Stocks down, Treasuries up, US dollar up, Gold up, but other commodities down. Fed Funds futures pricing in no more interest rate hikes this year. In many ways, markets were discounting #Bremain in the week or so heading up to the vote, so in many cases, they merely gave back those moves. Friday was volatile, with 3-sigma moves seen in 23 currencies, 30 sovereign bonds, and and 28 stock market indices.

What does Brexit mean to the European financial markets?  The banks got crushed on Friday, and part of that is due to widening sovereign spreads. Brexit caused a yield divergence between the German Bund and the PIIGS (Portugal, Italy, Ireland, Greece, and Spain) bonds. Greek spreads widened out 89 basis points to 8.65%. German bond yields fell 14 basis points to -5 basis points. While yields on the PIIGS are still low, they could become an issue going forward.

The biggest risk to the US is any sort of financial contagion. The tell will be the performance of the European and UK banks. Note Italy is considering injecting 50 billion euros into its banking system. The PIIGS are behaving this morning, but that will be something to watch.

Brexit has put the Fed in a box. The slowing economy in China plus the issues with Brexit have pretty much put them on the sidelines for now. In fact, the Fed Funds futures are beginning to price in the possibility of a rate cut. The bottom line is that rates will be lower for longer. FWIW, Bill Gross thinks the upside is limited in US bonds. While Brexit will probably dampen global growth slightly, it shouldn’t be a catalyst to push the US into a recession. The biggest beneficiaries will be tourists who want to visit the UK this summer. The biggest losers will be US manufacturers who compete with UK manufacturers and become less competitive due to the sell-off in the pound. In other words, the economic fall-out to the US will probably be pretty limited. Perhaps US stocks were looking for a reason to sell off, but the effect of Brexit on US corporate earnings should be pretty small.

In terms of the mortgage markets, the TBA market (which sets mortgage rates) really didn’t have much of a move on Friday. Ginnie II 3.5s were up about 1/4 of a point, which is more or less normal volatility. Fannie TBAs were up 3/8 of a point, which again is more or less normal volatility. Historically, TBAs have lagged movements in the bond markets, and days like Friday absolutely annihilate people who hedge MBS interest rate risk. So, while their portfolio goes up in value, their interest rate hedges lose a lot more than their book gains, so it ends up pressuring TBA pricing, which in turn prevents mortgage rates from moving as low as you think they should go. If the 10 year stays right here, expect mortgage rates to catch up only gradually over a week or even two. Note that the Bankrate US 30 year fixed rate mortgage had been lagging the moves downward in rates already, even before the big move on Friday. It dropped 11 basis points on Friday.

Construction wages are rising faster than the rest of the industry, however they are really just playing catch-up. It will make new houses marginally more expensive, however falling mortgage rates will cushion the blow.

29 Responses

  1. Frist!


  2. SCOTUS just held that you need to be actually corrupt before being convicted on corruption charges. what a world!


  3. NoVA, I think you pointed this out a while back:

    “Enforcing the Law Is Inherently Violent

    A Yale law professor suggests that oft-ignored truth should inform debates about what statutes and regulations to codify.

    Conor Friedersdorf”


    • ” I tell my Contracts students never to argue for invoking the power of law except in a cause for which they are willing to kill. ”

      I’ve certainly said that.

      Liked by 1 person

  4. Worth noting in the Brexit hysteria:

    “Cornwall, which is located in the U.K., may lose its E.U. subsidy — and the U.K. might stop shipping some of its money to Ethiopia. Do you suppose British subjects in Cornwall wonder why they have to depend on a subsidy from the E.U. in Brussels while their government in London is sending more than five times that amount to Ethiopia? Maybe U.K. voters would prefer that Cornwall look to London for assistance and Ethiopia could take a haircut on what they receive from British taxpayers. It makes sense that British voters would want these decisions made by their government in London.”


    • No, that’s silly. The #Brexit was all about racist old people hating their intellectual betters and not respecting the opinions of experts, but instead insisting that they should have something to say on how their lives are run, which is of course absolutely absurd.

      Anyway, we all know Britain is doomed if they don’t send money to Ethiopia and can set their own fishing quotas. It is known.


      • “As a rule, people resent being saved from themselves. And if you think depriving people of their right to make mistakes makes sense, you probably never had respect for their right to make decisions at all.”

        Is Matt Taibbi trying to get fired from Rolling Stone? This can’t be acceptable in the political stylebook. 😉

        “You have to be a snob of the first order, completely high on your own gas, to try to apply these arguments to present-day politics, imagining yourself as an analog to Plato’s philosopher-kings.”

        I cannot imagine anyone on the left is reading this with sanguinity. This is heresy.

        “And you have to have a cat-iron head to not grasp that saying stuff like this out loud is part of what inspires populations to movements like Brexit or the Trump campaign in the first place.”

        While I agree completely, this seems to cut against the Democratic/liberal grain.

        Well, he calls Trump’s call for a religious test for immigrants bluntly unconstitutional, which was not what Trump was calling for, so I guess he’s trying to say he still belongs with the in-crowd, “you guys just need to to say this stuff in public”. 😉


      • “He just left out the part where Plato, at least when it came to politics, was kind of a jerk.

        The great philosopher despised democracy, believing it to be a system that blurred necessary social distinctions, prompting children, slaves and even animals to forget their places.”

        Ha. i can endorse the elitism in that.

        Liked by 1 person

  5. Gotta hand it to the EU. They’ve got some might large balls.

    The foreign ministers of France and Germany are due to reveal a blueprint to effectively do away with individual member states in what is being described as an “ultimatum”.

    Under the radical proposals EU countries will lose the right to have their own army, criminal law, taxation system or central bank, with all those powers being transferred to Brussels.

    Controversially member states would also lose what few controls they have left over their own borders, including the procedure for admitting and relocating refugees.

    The plot has sparked fury and panic in Poland – a traditional ally of Britain in the fight against federalism – after being leaked to Polish news channel TVP Info.

    But others see the Brexit vote as an opportunity to push ahead with the European elite’s long-cherished dream of creating a United States of Europe.

    Spain’s foreign minister Jose Manuel Garcia-Margallo has called for “more Europe” whilst Italy’s finance minister, Carlo Padoan, is advocating a common budget for the eurozone states.

    And Emmanuel Macron, France’s economy minister, wants to go even further and set up a common eurozone treasury which would oversee the permanent transfer of funds from wealthier northern Europe to shore up Mediterranean economies.


  6. Good turn of phrase:

    “Trump, Sanders, and Ted Cruz have in common that they are political sociopaths—meaning not that they are crazy, but that they don’t care what other politicians think about their behavior and they don’t need to care.”

    I agree with the general analysis of the article where many of the current problems with American politics today are the result of previous “reforms” to try and reduce corruption, money, influence, etc.


    • No doubt, but still: “The middlemen could be undemocratic, high-handed, devious, secretive. But they had one great virtue: They brought order from chaos.”

      The virtue is not without a cost, though, and the chaos not without a benefit. The more chaotic it is in Washington, the less can actually be accomplished, and that’s not necessarily a bad thing, even if most of the politicians in DC come off as unrepentant douchebags.


    • Also, at least w/ Cruz and Trump, the party fought them ( and continues to) tooth and nail. They owe them nothing.


  7. Scott Adams changes his tune

    “What matters is that the “crazy racist” label picked up enough confirmation bias to stick like tar. The Clinton team won the month of June. And unless something changes, Clinton will saunter to an easy victory in November.”


    • I saw that and thought it just screamed CYA.


    • I think he’s missing the change in Clinton’s persuasion game over the past three weeks. She’s got better people on her side now. She’s stopped urging people to imagine Donald Trump as president, hasn’t used the words “President Donald Trump”, and has taken a “I’m the boss, you aren’t worth my time” approach with some of her tweets. On the whole, her persuasion game has been much stronger for the last three weeks, and I’m guessing it’s not going to slide backwards. They’ve clearly brought smarter people on staff to handle social media and general media presentation. He still thinks Trump will win the day, but I’m dubious. Given the effect of persuasion on partisans, the importance of peer groups on persuasion (when all your friends hate Trump, you’re just more likely to go along if you don’t have a strong ideological bent) and so on. There are too many factors from Trump to master, but I still think it’s going to be a close election, and may go #Brexit on us no matter what the polls leading up say.


  8. I have offered some form of the following at two liberal web sites, without a response.


    This is perhaps the most transparently stupid idea I can imagine a smart but tax illiterate person to propose.

    From her web page:

    Award a two-year tax credit to companies that share profits with their employees. Under Clinton’s plan, companies that share profits with their employees would receive a two-year tax credit equal to 15 percent of the profits they share – with a higher credit for small businesses. Shared profits eligible for the credit would be capped at 10 percent on top of employees’ current wages. This would help companies overcome any initial costs of setting up a profit sharing plan. After two years, companies that have established profit sharing plans and enjoyed the benefits of them would no longer need the credit to sustain the plans.


    So If I pay $1M in “profit sharing” out in bonuses I am taxed on the profit at 35% but get a 15% credit. However, if I just pay out $1M in bonused salary and wages I reduce my taxes by 35% on that $1M because it is deductible as an expense.

    HOW STUPID – and she keeps repeating it as if it is a “plan”.


    • This is the part that gets me: “After two years, companies that have established profit sharing plans and enjoyed the benefits of them would no longer need the credit to sustain the plans.”

      But what if they aren’t—and sometimes they won’t, even under ideal circumstances? And why two years? Why not 1? Or 3?

      If she was serious she’d be offering 50% of the profits they share as a tax credit. or 100%. Push the envelope, Hillary!

      But, not surprised. I don’t recall much of what was in HRC’s healthcare proposal back during the Clinton admin, but as I recall it was full of stuff like that.


    • I don’t think that’s right. I think that the “profit sharing” that goes to employee compensation is also already deductible as an expense, so the 15% credit is a subsidy on top of that to defray start up costs, as noted.

      Internet seems to think it’s viewed as a type of retirement plan.

      From the IRS:

      “Contributions and earnings generally are not
      taxed by the Federal Government or by most
      state governments until they are distributed.”

      Click to access p4806.pdf


      • JNC, That would make more sense than how it is written in her campaign brochure. The way it is written, it sounds as if the profit share would be distributed like a dividend – but with a tax break.

        There are existing profit sharing plans that are actual retirement plans.


        So I am left with wondering if she is tinkering with 401k.

        And why does she think a company that can’t afford the plan because it has no significant profits would think a tax break on small income would encourage distributing it to labor, rather than holding it for reinvestment/reserves?

        A company that already has a plan is apparently excluded from her deal or would have to set up an additional plan.

        Addendum: law firms are big users of 401K and SEP-IRA and the like, and do not limit employee share to a 10% bonus. So that when a firm wins a huge case, it might give a bonus through the plan equal to a year’s salary to each of the legal assistants. Really. I gave one that big myself, once.

        Liked by 1 person

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