Daily Agenda: Brexit and Yellen Share the Spotlight

With the Brexit referendum now once again too close to call, investors find themselves in a holding pattern, waiting for the conclusion. Despite the divergence between sentiment indicators ahead of the referendum, the pound sterling continued to strengthen versus major currencies in trading this morning. Federal Reserve chair Janet Yellen will visit Capitol Hill for two days of testimony before the House and Senate, an opportunity for lawmakers to grill her on the likely pace of future rate hikes as well as possible risks to the U.S. economy posed by macroeconomic headwinds. Across the Atlantic, European banks are preparing for an extraordinary experiment as the European Central Bank gears up to roll out a zero-to-negative lending window starting on Wednesday. With so much at risk for financial assets, many investors are likely to be content to wait on the sidelines until the effect of political and policy shifts clarifies.

AXA announces new strategy. AXA released a statement today detailing plans to trim billions of euros in costs and to increase investments and acquisitions in a move to boost profit growth. France’s largest insurer is targeting a per-share profitability increase of up to 7 percent annually in the next four years. The announcement comes just months after the ascension of Thomas Buberl as Axa’s CEO.

Few details on Abu Dhabi bank merger. After confirming on Sunday that National Bank of Abu Dhabi and First Gulf Bank are in merger discussions, neither set of management has provided much in the way of information to investors. Based on current share prices, the total market capitalization of the combined banks could exceed $30 billion and become the largest in the region. Both banks have suffered from the impact of lower oil prices on borrowers.

PBOC considers opening door to offshore yuan markets. In an online statement today, People’s Bank of China officials revealed ongoing discussions with financial institutions over access to foreign yuan markets, an attempt to close the gap between exchange rates at home and abroad. The announcement followed one earlier this year in which the central bank said it will allow foreign banks to access domestic yuan markets in the near future.

EU announces new corporate tax measures. In a statement released today, the European Council said that all 28 member states had agreed to a compromise agreement hammered out last week to close corporate tax loopholes within the common-currency zone. The directive follows a European Commission proposal in January to crack down on the shifting of profits between different tax regimes within the EU.

German sentiment leaps in June. Economic sentiment data published by the Zentrum für Europäische Wirtschaftsforschung (ZEW) today indicated that the mood among institutional investors in Germany improved sharply in recent weeks, with the headline index registering at 19.2 versus a prior 6.4. The current situation sub-index also rose by a higher margin than forecast, as gains by the Remain movement in the U.K. and fresh policy measure by the ECB gave cause for optimism.

Portfolio Perspective: Brexit Boosts Volatility in Equity and Credit Markets — Jeff Saret, Gerardo Manzo; Two Sigma Investments

Since November 2015, Brexit risk appears to have affected U.K.-listed stocks and credit markets more than other assets. On days when changes in Brexit-volume was two standard deviations above the mean, the variance of U.K.-listed equities (proxied by the FTSE) was nearly 2.5 times greater than on other days. Similarly, the variance on the credit-default swaps of the U.K. government was more than three times greater than other days. Brexit searches had no statistically significant effect on U.K. ten-year sovereign debt or European CDS spreads. These results appear consistent with the belief that Brexit would adversely affect the long-term real economy by harming corporate profitability, reducing both earnings and the ability of financial institutions to manage their debt.

Conversely, the variance on the pound was lower on days with relatively abundant Brexit searches. One potential explanation is that if Brexit occurs, the Bank of England would adjust monetary policy to try to stabilize the broader economy. Since monetary policy has a more direct effect on exchange rates than on equities or credit, Brexit might pose less of a risk in the forex markets than elsewhere. An alternative explanation is that global macroeconomic conditions, such as changes in oil prices, have a relatively larger effect on exchange rates than on U.K. domestic equity and credit markets. Since Brexit-search volume as a percentage of overall searches was lower on days of global macroeconomic uncertainty, a muted effect on the pound seems plausible. This second explanation also appears consistent with the data showing non-pound currencies (e.g., U.S. dollar and euro) had significantly lower variance on high Brexit news days.

Jeff Saret and Gerardo Manzo are members of the Thematic Research group at Two Sigma Investments in New York.