Yesterday was somewhat reminiscent of the Feb 11 capitulation day, especially in bonds where yields spiked to new lows in the morning and then pulled back as the murder of MP Jo Cox apparently caused a sentiment shock. GBP reversed, as did gold, stocks etc. Clearly, the Brexit vote has transfixed global markets, and given recent risk averse moves, a ‘stay’ vote will cause substantial unwinding. For example, treasury vol closed at recent highs; I marked USU at 12.1 and TYU at 6.0. The ten year swap reached a record low yield early in the session, sub 140 bps, below the previous low last seen during the European crisis of 2012. Ten year treasury closed -3.6 on the day at 155.8. These levels are unlikely to hold if Britain remains.
A stay vote will also change market perceptions about chances for a Fed hike, that have now been squeezed down to pulp. For example, Dec’16 FF closed up 2 at 9955.5. So there’s currently just an 8 bp premium until year end (FFM6 is 9963.25). And October FF, which cover the next two FOMC meetings in July and Sept, closed at 9958.5, signifying only about a 20% chance of a hike at one of those two meetings.
Of course, there are now trades being entered predicated on an ease from the Fed, as activity in the 9950 strike in EDs attests. All of this makes Yellen’s testimony next week relatively unimportant. There is clearly dissension within the Fed, though estimates of the terminal rate continue to begrudgingly move lower. EDZ19 closed at 9869.5, a yield of 1.305, consistent with a FF target of 1.0-1.25%, and that’s three and half years away.
