Q2 2016 FFTW Quarterly Commentary: Should I Stay or Should I Go?

11 Jul 2016


In this paper, we take a look at following topics:

  • The fallout from Brexit and its potential implications on global growth and recovery;
  • Active management in this high volatility regime is demanding a much more tactical approach than in previous years;
  • Cross-currents of the second quarter have given way to an all-out emerging market assets rally; and
  • What are our expectations for the second half of of the year?


The 1981 cult classic hit from the British punk rock band “The Clash” could not have been more prophetic in describing the angst the world would face some 35 years later. While the song was exactly titled to describe the English referendum of June 23rd to stay or leave the EU, the song also accurately references the question that many central banks around the globe now face as they rethink monetary policy. One can also draw a parallel to discussions of corporate boards around the globe as they too recalibrate their growth plans for the second half of 2016 and beyond in the face an even more uncertain global economic backdrop. Additionally, there will be discussions by regulators and by the global money-center banks with operations in the UK as to whether London will continue to be a financial hub for operations. To be sure, the vote for Brexit was a watershed moment. We have published quite a lot about the politics, the economics and the market’s response to the vote, so I won’t use this space to repeat what we already know nor belabor the potential outcomes that are still unknowable. Suffice to say that the currencies closest to the epicenter sold off in record breaking magnitude and have since stabilized; safe haven government bonds rallied to new lows and remain there. This results in even deeper negative yields in places like Europe and Asia, and risk assets got pummeled around the world when the outcome of the vote was released, but have since retreated as well. As a result of the Brexit vote, the likelihood of a Federal Reserve (Fed) hike has dropped to zero for the rest of 2016. Markets are forecasting only an 8% chance of a hike as far out as the second quarter of 2017 (a drop from a 97% certainty only six months ago). As such, the lower-for-longer regime will likely continue to drive investor behavior for the foreseeable future.

Today, given the fallout from Brexit and its potential implications on global growth, we now see a re-convergence of policy toward greater accommodation. So while the market maintains a healthy skepticism regarding the efficacy of central bank policy, it is almost impossible to ignore the power of their likely response and resolve in the face of additional crisis. In short, if the Fed is now set to pause further, rates will remain lower-for-longer and risk assets should benefit. If the European Central Bank (ECB) is committed to its purchasing program, and might even expand quantitative easing (QE) further, risk assets should benefit irrespective of fundamentals. And if both the ECB and Bank of Japan (BoJ) hold interest rates below zero for some time to come, investors will be forced to seek yield elsewhere. Therefore, despite the fact that economic and credit fundamentals have been deteriorating around the globe, and that political turmoil continues to mount, the animal spirits drumbeat has actually gotten louder in the second half of 2016. This is certainly one of the reasons why we have seen a retracement in equities, credit and peripheral sovereign spreads toward their pre-Brexit levels. Other reasons include the realization that none of the questions surrounding Brexit will be answered for months or even years to come and that markets can’t possibly go down by 3% every day in perpetuity!

When long-term strategies play-out in hours…

When writing a three month forward looking document, it is typically easy to start well in advance of the due date as well thought-out allocation ideas tend to take time to come to fruition. This quarter however, it was common to develop a theme, only to see it play out in its entirety over the next 48 hours and then reverse again. What that means is that active management in this high volatility regime is demanding a much more tactical approach than in the past. To illustrate this, it might help to share our tactical maneuvering during the last 10 trading days of June.

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