Markets had the feel Wednesday of the calm before the storm. Major stock, bond and currency markets did little more than meander ahead of what many are calling Super Thursday. That's when the U.K. holds a very important general election, the European Central Bank announces its decision on monetary policy, former FBI director James Comey testifies to the Senate about Russian meddling in the U.S. election, and Brazil's Electoral Court may issue a decision on campaign corruption that could unseat President Michel Temer.
Taken together, the events have the potential to shake markets out of the low-volatility rut they've been in for months, and they may show whether investors really are too complacent. Investors have discounted geopolitical risks as idiosyncratic and focused instead on a global economy that’s powering ahead amid persistently low inflation, according to Bloomberg News's Ye Xie and Anchalee Worrachate. Take the Bank of America Merrill Lynch's Market Risk Index, which just touched its lowest level since late 2014. The gauge is a measure of expected future price swings implied by options markets tied to global equities, rates, currencies and commodities. For this index, levels less than zero indicate less stress than is typically normal, while levels greater than zero point to the opposite.
According to Bill Gross, who manages the $2 billion Janus Henderson Global Unconstrained Bond Fund, markets are at their highest risk levels since before the 2008 financial crisis because investors are paying a high price for the chances they’re taking. “Instead of buying low and selling high, you’re buying high and crossing your fingers,” Gross said Wednesday at the Bloomberg Invest New York summit. Central bank policies for low and negative interest rates are artificially driving up asset prices while creating little growth in the real economy and punishing individual savers, banks and insurance companies, according to Gross.
The pound could plunge to as low as $1.20 on Friday, a level last seen in January, should the U.K. snap election lead to a hung Parliament, according to a Bloomberg poll of analysts. Such an outcome, though seen as unlikely, would be marginally more negative than even an electoral upset that sees the Labour Party defying odds to emerge the winner, according to the survey of 11 banks and brokerages. That suggests investors don’t share Prime Minister Theresa May’s view that when it comes to Brexit, not having a deal is better than a bad one, according to Bloomberg News's Anooja Debnath and John Ainger. A victory for May’s Conservative Party would be supportive of the pound, and this outcome is more or less already priced in, the analysts say. They also highlighted that the shorter- and longer-term effects on the currency could be different. While a strong Tory win provides near-term certainty and helps the sterling, over a longer period it could “increase the odds of a harder Brexit, which would probably be consistent with the pound being lower,” said Andrew Sheets, chief cross-asset strategist at Morgan Stanley.
MORE PROOF THAT INFLATION IS NO THREAT
The euro came under pressure ahead of the ECB meeting, falling versus most of its G-10 peers, after euro-area officials familiar with the matter told Bloomberg News that the central bank is considering lowering its inflation projections. The shared currency dived from about $1.1282 to as low as $1.1204 before recovering. The ECB’s draft projections now show consumer-price growth at around 1.5 percent each year in 2017, 2018 and 2019, the officials said, asking not to be identified because the information is confidential. The previous projections in March foresaw rates of 1.7 percent, 1.6 percent and 1.7 percent, according to Bloomberg News's Paul Gordon and Alessandro Speciale. A downgrade to the inflation outlook would back the view of top policy makers, including President Mario Draghi and chief economist Peter Praet, that they must be extremely cautious in communicating and implementing any exit from monetary stimulus. The Governing Council is set to debate how to balance policy for the euro area as growth solidifies but inflation remains muted.
OIL GLUT BUILDS
One area of the markets that had some action was oil. Crude tumbled to its lowest point in four weeks as an unexpected increase in U.S. oil and gasoline stockpiles stoked fears that the global supply glut will remain unabated, according to Bloomberg News's Meenal Vamburkar. Futures fell as much as 4.7 percent in New York after the Energy Information Administration said American crude supplies rose by 3.3 million barrels last week, following eight straight weeks of declines. Gasoline inventories rose by about the same amount. While U.S. oil imports from Saudi Arabia plunged 55 percent, shipments from Iraq surged to their highest level since 2012. "This is really unexpected," said Gene McGillian, market research manager at Tradition Energy. "It really looks as if fears of oversupply is what’s driving the market." Oil has traded below $50 for the past couple of weeks amid speculation that rising U.S. output will counter supply curbs by OPEC and its partners, including Russia. U.S. crude production will average more than 10 million barrels a day in 2018, breaking a record almost five decades old, according to the EIA’s monthly Short-Term Energy Outlook report Tuesday.
CHINA IN REBUILDING MODE
China’s foreign-exchange reserves climbed for a fourth month, the longest streak since June 2014, as the yuan rallied and tighter capital controls curbed outflows. Reserves climbed $24.03 billion to $3.054 trillion in May, the People’s Bank of China said Wednesday, above the $3.046 trillion estimate in a Bloomberg survey of economists. Fresh rules imposed by the authorities this year have made it harder for investors to move money out of the country, arresting a slide in reserves that shrunk the stockpile from a peak of almost $4 trillion in 2014, according to Bloomberg News's Xiaoqing Pi and Miao Han. "I don’t think capital outflow pressure is the problem now," said Larry Hu, head of China economics at Macquarie Securities in Hong Kong. "The key question is when and how to relax capital controls and open the capital account further." That's important because MSCI on June 20 will say whether it will allow China's A shares to be included in its benchmark indexes. Goldman Sachs strategists say they give that a 60 percent chance of happening, prompting equity index flows of $210 billion over the next five years.
Yes, there's a lot going on tomorrow, but don't forget to keep an eye on Canada. The Bank of Canada will release its semi-annual Financial System Review and investors will be watching for what the central bank says about the nation's red-hot housing market. In the last FSR in December, the Bank of Canada listed elevated household indebtedness, housing market imbalances and fixed-income liquidity as the three main risks to the financial system, and Goldman Sachs economists say that the focus should be similar this time. Toronto home prices rose almost 30 percent last month from a year earlier, the city’s real estate board said Monday. In Vancouver, the country’s most expensive real estate market, they’ve climbed 58 percent over four years. Meanwhile, household debt is at record levels, surpassing gross domestic product for the first time. Fitch said Wednesday that banks with greater exposure to those two cities are more sensitive to a market correction.
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