S&P cut UK credit rating to AA from AAA

June 28, 2016

FX News Today

S&P cut UK’s credit rating to AA from AAA, noting the Brexit vote was a “seminal event.” The outlook remained negative, which had been adopted in the spring. Both S&P and Moody’s warned of this potential on Friday. The rating agency downgraded its 2016 to 2019 average growth forecast to 1.1% average per year, from 2.1%. S&P also said the vote for “Remain” in Scotland and Northern Ireland creates wider constitutional issues. The BoE’s long-term issuer credit rating was also lowered to AA from AAA, with a negative outlook.

It seems stock markets are trying to take a breather after the recent carnage and most Asian markets are slightly higher, while U.S. and U.K. stock futures are also rebounding. Negative leads then for bond futures, which managed to rise to new record highs yesterday while yields continued to slide, with the 10-year Gilt yield below 1.0% and the Bund yield below -0.1%. Even the Geramn 5-year yield fell below the ECB’s deposit rate yesterday, which means it is no longer eligible for purchases under the QE program, putting pressure on Draghi to cut the deposit rate once again.

EU Parliament, and EU summit to discuss Brexit. Tomorrow, the U.K.’s intentions following the Brexit referendum may become a little clearer – or maybe not. The EU Parliament will meet tomorrow to discuss the referendum and an EU summit starts, that was slated a long time ago, moved to avoid a clash with the referendum and now will have the Brexit referendum as its main topic. Hopes that Cameron will already evoke Article 50 tomorrow at the start of the summit seem to be fading fast as the U.K. clearly is in no rush to start official proceedings. Cameron wants to leave the main task of negotiations to his successor, but won’t step down for another 4 months. Boris Johnson meanwhile still seems to be hoping for informal negotiations ahead of an official step that would start the U.K’s exit from the EU. Indeed, it often seems he doesn’t want the U.K. to leave, just to get better terms: i.e. access to the single market, free movement for U.K. citizens, but no payments to the pot, no acceptance of EU legislation (although that would only be phased out very slowly) and a point based immigration system. A squaring of the circle and a difficult task. For markets this means it is unlikely that much will be clearer after the summit, only that we will have to live with considerable uncertainty about the U.K.’s future relationship with the EU for quite some time.

USDJPY price action has been relatively muted through the session, following the huge 106.83 to 99.00 range seen in the immediate aftermath of the Brexit outcome. The pairing peaked at 102.48 in Tokyo overnight, though as European and U.S. equities turned lower, the yen turned higher on the risk-off condition. USDJPY later found support at 101.40, as sellers remained nervous of intervention. The BoJ was rumored to have sold yen last Friday when UDSJPY was below 100.00. Japan Finance Minister Aso didn’t confess to this but said that firm action on the yen will be taken if needed, although premature to discuss joint intervention. He said that Japan will respond to FX moves, if needed, “more than ever” and is watching with a “sense of urgency.” Kuroda has been reported to say earlier that central banks are ready to take steps to assist proper financial markets  functioning.

Dallas Fed’s manufacturing index improved 2.5 points to -18.3 in June after tumbling 6.9 points to -20.8 in May. This is an 18th consecutive negative print, which reflects contraction. Of course the oil-rich Dallas region has been hard hit by the collapse in “black gold” prices. U.S. Markit services PMI was steady at 51.3 in the June preliminary report, compared to May, reflecting positive but subdued growth. The index was 54.8 a year ago, and has generally been slipping since hitting 56.1 in August (it hit a recent low of 49.7 in February).

Main Macro Events Today

ECB Draghi’s speech: ECB president Draghi is expected to speak about the consequences from Britain’s decision to leave the EU and comment on potential measures the ECB is taking to counter uncertainty and potential recession in the Euro Area economies.

US Gross Domestic Product: In the third release of the US Q1 GDP is expected to be confirmed at 1% (annualized). Forecast risk: downward, given the huge inventory boost that is being unwound. Market risk: downward, as weakness may slow the path of additional Fed rate hikes.

US PCE Prices: Fed’s favourite inflation measure Personal Consumption Expenditures deflator is expected to come in unchanged at 0.3%.

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