Friday, June 24, 2016
If you haven’t heard, Britain has been weighing the decision to leave the European Union (EU). This has been coined “Brexit” by the media, which cleverly stands for Britain exiting the EU.
Following a very close vote on Thursday by U.K. citizens of 52% to 48%, the British parliament decided to exit the European Union. Today, Prime Minister David Cameron resigned subsequent to the decision stating “the British people have made a very clear decision to take a different path, and as such I think the country requires fresh leadership.” Cameron will remain in office at least a few months until a replacement is announced, which should be prior to the annual conference in October. Brexit presents additional challenges for German Chancellor Angela Merkel after years of struggles. The next main question to answer is who will lead Britain’s negotiations. Merkel will likely want to take a firm stance and make an example out of Britain to send the message to other countries to remain in the EU. Boris Johnson, a former London mayor, helped lead the “leave” campaign and considers this a victory. Johnson is on a short list of possible replacements to succeed Cameron. One of the larger unknowns at this point is which, if any, countries will follow suit and withdrawal from the EU. Potential concerns as a result of Brexit are the trade implications as well as the regulatory and political volatility created. Specifically, international companies that trade with the EU through Britain may have restricted access and investment channels and trade agreements will have to be renegotiated. This process will likely take several years.
Upon the open of the US domestic markets, stocks fell sharply and Treasury prices soared. Major US equity markets fell almost three percent on the open and volatility swelled. As a flight to quality, gold rallied to over $1,300 per ounce. The yield on the 10-year Treasury fell about thirty basis points at its lowest, trading as low as 1.4%; this represents the lowest it’s been since mid-2012. Crude oil fell around 7% per barrel. European stocks also fell, approximately 6% on Friday, on track for their largest decline since 2008. The British pound has fallen over 7% and is on track for one of its worst days on record.
So, what does all of this mean for the US insurer? Treasury rates are lower which creates larger unrealized positions. Although trading in the bond market is extremely light today, investment of cash would occur at significantly depressed levels compared to yesterday. As far as fundamentals, we don’t believe much has changed domestically. This is merely a flight to quality which has resulted in driving down yields for the short term. For bond investors, the coming days and weeks could be a great time to consider strategic swaps to remove credit concerns from the portfolio while taking advantage of larger unrealized gains that might offset potential losses. For those with equity exposure, Friday will likely prove in hindsight to have been a great time to average into the market. As far as the Federal Reserve and future rate decisions, implied probability of federal funds futures dropped today to a zero percent chance of any rate hikes until December. In fact, the market is pricing in a slight chance that the Fed will cut rates. While we don’t believe any rate cuts will occur, the likelihood of any rate hikes at this point has virtually disappeared for at least the next couple of meetings.
Parkway Advisors, L.P. is an investment advisor registered with the Securities and Exchange Commission offering investment management, consulting, and statutory reporting services. This material is for your use only and has not been independently verified and thus we do not represent that it is complete and should not be relied upon as such. The opinions expressed are our opinions only. Past performance is no guarantee of future performance and no guarantee is made.
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