Morning Report: Brexit 6/24/16

Stocks are getting sold this morning after the UK voted to leave the EU. Bonds and MBS are up.

Last night the UK voted to leave the EU, which was a surprise to the markets. European stocks are getting crushed this morning, and the biggest ones taking a hit are the banks. Barclay’s is down 17%, Santander is down 18%, for example, so there is the distinct possibility of some sort of banking crisis over there. Note we are not seeing a huge move in US banks, so it looks like any crisis over there isn’t going to spill over to the US banking sector.

Big picture: The Fed is doing nothing – in fact there will be calls for the next move to be a rate cut. This could cause a mild recession over here, which means lower rates.  In fact, durable goods orders were terrible this morning, down 2.2%. One of the big investment banks was calling for a 1.4% 10 year bond yield if the UK left. The 2 year bond yield dropped 14 basis points to 64 bps, That will be the one to watch to get a read on what the market thinks the Fed will do.

In terms of mortgage rates, the TBAs (which determine mortgage rates) will lag the move downward in yields. For example, the Fannie Mae TBAs are up this morning, but nowhere near the move in bonds. So, while the 10 year bond yield will get everybody excited, don’t expect a huge move downward in mortgage rates, at least initially. Once the 10 year finds its level, TBAs will find their level, probably over the next few weeks or so. If the European banking system goes into full crisis mode, the impact on mortgage rates will probably be a pull-back in jumbo pricing, which is the most vulnerable since it relies on a private securitization market. FN and GN pricing should not be affected. So basically, we will see some drama in the stock and bond markets, and not so much in the mortgage markets.

UK Election Next Week: “Economist” endorses Cameron 5/1/15

About Labour, this: Mr Miliband is fond of comparing his progressivism to that of Teddy Roosevelt, America’s trustbusting president. But the comparison is false. Rather than using the state to boost competition, Mr Miliband wants a heavier state hand in markets—which betrays an ill-founded faith in the ingenuity and wisdom of government. Even a brief, limited intervention can cast a lasting pall over investment and enterprise—witness the 75% income-tax rate of France’s president, François Hollande. The danger is all the greater because a Labour government looks fated to depend on the SNP, which leans strongly to the left.   http://tinyurl.com/nwqjron

Kicking the can down the road

It looks like the pro-bailout party is going to win in Greece, which means Greece will continue with mandated austerity and Europe will continue to bail out Greece. At least for a time.

Markets in Japan haven’t opened yet, but stocks should rally and bonds will sell off, at least temporarily.

European Contagion

There is quite a lot in the news about the Euro crisis. I’m skeptical of claims that a Euro implosion would be disastrous for the U.S. economy. First off, Greece being ejected from the Euro doesn’t mean the end of the Euro. Just that Greece was brought in with an overvalued currency and with the full knowledge that the books were cooked. The U.K. was ejected from the Euro’s predecessor 20 years ago. That event propelled a dramatic economic recovery from disastrous interventions to stabilize its currency. It’s also the primary reason Labor was in government from 1997 to 2011. Even with larger knock on effects, the Euro zone is not a significant growth market for U.S. exports and an economic slow down might have a knock-on effect for materials prices. The U.S. performance this year tracked fairly well with oil. I’m likely wrong about this, but I don’t see this as our greatest challenge.

The most interesting piece that I read was a graphic in today’s Post illustrating U.S. exports to Europe. As I expected, exports to the southern tier countries aren’t that great. I expected the bigger EU countries (U.K., France, Germany) to make up the lion’s share. The shocker to me is that the largest market for us is Benelux (Belgium, Netherlands, Luxembourg), accounting for roughly $55B of U.S. exports per year, well ahead of the U.K. at $42B. One might quibble with me combining the three countries, but our Benelux exports rival those to Germany and France combined ($58B). For the record, here’s the top 10.

Country Imports Exports
Canada $237B $210B
Mexico $196B $146B
China $292B $74B
Japan $92B $49B
United Kingdom $38B $42B
Germany $72B $36B
Korea, South $43B $33B
Netherlands $18B $32B
Brazil $22B $32B
Hong Kong $3B $27B

Incidentally, there is only one country that shows zero imports or exports to the U.S.–Yemen. Unless you included postal bombs.

BB

Don’t Forget Greece

Everyone is anxiously waiting to see the results of Greece defaulting on its debt and how it will affect the rest of us. Are they really going to default? It appears there’s not much left to try even though the confidence boosters keep trying to delay the inevitable and give us happy talk while we wait.

I’m not much of an economist and so I thought this piece in the NY Times was a good read about where things stand and where they’re headed, especially for those of us who are interested in the story but can’t quite wrap our minds around the global market and what a Greek default might mean for us.

We could call it “Greek Default for Dummies” (like me). Hopefully some of you reading this will have more to say. There was a piece in the Financial Times I couldn’t get to because of a pay wall. Maybe someone here could give us the hightlights?

Greece Nears the Precipice

A few highlights from the piece:

A default would relieve Greece of paying off a mountain of debt that it cannot afford, no matter how much it continues to cut government spending, which already has caused its economy to shrink.

At the same time, however, there is a fear of the unknown beyond Greece’s borders. Merrill Lynch estimates that the shock to growth in Europe, while not as severe as in the aftermath of the financial crisis of 2008, would be troubling, with overall output contracting by 1.3 percent in 2012.

While other countries have defaulted on their sovereign debt in recent times without causing systemic contagion, analysts weighing the numbers on Greece note that its debt is far higher, so the ripple effects could be more serious.

Total Greek public debt is about 370 billion euros, or $500 billion. By comparison, Argentina’s debt was $82 billion when it defaulted in 2001; when Russia defaulted, in 1998, its debt was $79 billion.

Willem Buiter, the chief economist at Citigroup, presents two possible default outcomes. In the first, Greece forces private sector creditors to take a loss on their bonds of 60 to 80 percent but manages to stay inside the euro zone by keeping current on the smaller amount that it owes its official lenders, like the European Union and the I.M.F.

While technically a default, the loss would not be an outright repudiation of Greece’s debt and the contagion could, in theory, be contained.

One big unknown revolves around the fact that, unlike other countries that have defaulted on their debts in the past, Greece does not have its own currency.

The potentially more dangerous default outcome is if Greece decides to leave or is forced to leave the euro, according to Mr. Buiter. Then, Mr. Buiter believes, the debt write-off would approach 100 percent and the effects on international markets could be much more serious.

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