iTrust Daily Insight

18th October
iTrust Daily Insight
Edition 10.17.2019

October 17 — Brexit vote likely to be major driver for markets for next two days 

Market data as of about 4:30pm PT7:30pm ET12:30am (ie 0:30) London time

  • Gold “F” futures contract: $1496 (source: Yahoo Finance)
  • Silver “F” futures contract: $17.57
  • Copper “F” futures contract: 2.6000 (Yahoo Finance)
  • Oil “F” futures contract: $54.01 (Yahoo Finance)
  • DJIA: $27,026 (up slightly)  (Yahoo Finance)
  • S&P 500: $2,998 (up 0.3%) (Yahoo Finance)
  • FTSE (main London stock index): 7,182 (up 0.2%) (Yahoo Finance)
  • Shanghai stock index: 2,977 (very slightly lower) (Yahoo Finance)
  • VIX (volatility implied in near contracts of S&P 500 futures in US): 13.70
  • Probability of 25 bps cut at Oct 30 meeting of US central bank (Fed FOMC): 85% — up from 20% a month ago (source: CME Group’s “CME Fed Watch Tool”)
  • Probability O/N rates are unchanged from current rates (1.75%-2% target range) after Dec 11 FOMC meeting: 11%
  • Probability O/N rates are only 25 bps lower than now after Dec 11 FOMC meeting: 69% (source: CME Group’s “CME Fed Watch Tool”)
  • Probability O/N rates are 50 bps lower than now after Dec 11FOMC meeting: 20% (source: CME Group’s “CME Fed Watch Tool”)
  • US 10 year Treasury yield: 1.755% (basically unchanged today) (WSJ.com)
  • US 2-10 yield difference: +0.16% (i.e., positively sloped —normal — yield curve) (WSJ.com)

Today’s big news:

1) The United Kingdom and the EU have agreed to a draft agreement allowing the UK to withdraw from the European Union while also ensuring no physical border on the Irish island between the UK province of Northern Ireland and the independent, former colony the Republic of Ireland

2) all 27 heads of state of the respective EU countries who happen to be gathered in Brussels for a summit have already approved the deal

3) the British parliament will vote on the measure on Saturday (October 19)

4) see #1, #2, #3

5) we remind investors of digital currencies that such markets are global and do not close; we urge paying close attention to events as they unfold over the next two days

6) of course investors can always access physical gold through local vendors but financial markets based on physical gold are closed only for a short time during the weekend.  Markets open in the Far East, move to Europe and then to the Americas.  

Market commentary for today:
Yesterday is already gone

As we commented yesterday and this morning, we believed the “good news” of a more likely “soft Brexit” was getting increasingly “baked in” to asset prices (gold, digital currencies, national currencies, equities, and bond & interest rate markets).

We also commented that the “big news” within the relatively tiny world of digital currencies was the apparent (at least temporarily) failure of FaceBook’s digital currency, Libra.

Yesterday, digital (crypto) currency prices fell on the apparent disappointment of lower prospective legitimacy and liquidity.

Brexit is what is most likely to matter most over the next three days

However, today, with that Facebook news already in the rear-view-mirror, the big news is the apparent breakthrough in Brexit negotiations between the UK and the EU.

To the extent, the UK parliament agrees to the draft proposal which has already been accepted by the EU, then there will be a “soft Brexit” and, we expect, the markets will foresee a release of the pent-up investment which has been on hold awaiting status of the Brexit negotiations.

To the extent the UK parliament turns down the draft proposal and required the UK government to ask the EU for more time to negotiate more — even though the current draft has already been accepted by the EU heads of state — we believe this will be seen as highly disruptive.

Scenario one: UK approves the draft proposal, leading to a soft Brexit

If the deal is approved by the UK government, gold and digital currency prices may goup to the extent market participants will be clamoring for a hedge against future inflation — which pressures may build after the constraint of Brexit negotiations will have been removed.  

On the other hand (I know, I know … can’t we get a one-handed economist?)…

On the other hand, if the UK government approves the deal but gold and digital currency market participants now have less fear of severe disruption which would have led to future purchases of gold and / or digital currencies, prices of such assets may go down.

In other words, traders and investors must assess whether more holders of gold & digital currencies care more about possible future disruption or future inflation.  If more holders & potential investors of gold & digital currencies care(d) more about future inflation then gold & digital currency prices are more likely to go up if the UK parliament approves the deal.  And if more holders & potential investors of gold & digital currencies care(d) more about having a safe haven in case of severe shock then gold & digital currencies prices will likely go down.

Scenario two: UK rejects the draft proposal, leading to a high chance of a “hard Brexit

Now, let’s look at the other scenario: what happens if the UK rejects the draft proposal?

We continue to believe a hard Brexit will only have short-term consequences.  Brexit is currently scheduled for October 31 — irrespective of whether there is a deal between the UK and the EU for the UK to exit.  

However, we remain very, very confident that either the sun will come up on November 1st or it will be raining on November 1st.  Either way, we are very, very confident that on the day after Brexit the world will keep spinning and the world will quickly adjust to Britain no longer being a part of the EU.

In other words: 1) there will not be a physical border between Northern Ireland and the Republic of Ireland — no one is building one and no one wants to build one, 2) whatever trade status exists between the EU and UK will be quickly determined either by many bi-lateral agreements or within the confined of the World Trade Organization or something new between the UK and the EU at large, and 3) et cetera.

However, in the short run, we also believe most market participants will see a no-deal Brexit according to the “common wisdom” that it will also be a “hard Brexit” — leading to corollary fears of trade reductions, travel reductions and other disruptions which will be bad for the economies of both the UK and the EU.

If we are right that such fear rises very quickly, we would expect both gold prices and digital currency prices also to rise — to the extent they are seen as a “safe haven” for the protection of wealth during times of extreme market stress.

However, gold and digital currency prices will fallto the extent they are seen mostly as a hedge against future inflation which risk will reduce if economic growth is more likely to turn negative.

There are many, many scenarios to consider.

We have done our best to lay out some arguments for how markets are likely to react over the next few days.  

Obviously — but to state the obvious anyway — these prognoses assume no other major news events.  A breakthrough regarding China’s forward protection of intellectual property or a breakthrough regarding US-China trade, for example would also dramatically affect markets.

We will share more tomorrow how market participants can glean more clues about what other market participants in other parts of the world or in other trading arenas may be thinking as you / they try to stay ahead of events and position your / their portfolios accordingly.

As always, please contact Blake Skadron with any questions.   If he can’t answer all your questions, our Economics Team will get back to you with answers as soon as possible.

Tim Shaler is Chief Economist of iTrust Capital.  He is a published Real Estate economist, was a portfolio manager and asset allocation expert at his previous firms and is an adjunct professor at Webster University. His MBA (Finance) and MA in Russian Economic History are both from the University of Chicago.

For all media inquiries, please contact Blake Skadron at b.skadron@itrustcapital.com.

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