Tilting the balance of risk

With the confluence of the impending Brexit referendum and the ongoing European football championships, the temptation to make the odd analogy (or at least the odd joke) is nearly irresistible.  After the latest 90 minutes of dross served up by the England football team against Slovakia yesterday, it occurred to your author that the fantasists who think that "this will be England's year" in the run-up to every major tournament were reminiscent of blithe belief in some quarters that the UK will simply waltz their way into new free trade agreements should they leave the EU: the triumph of hope over expectation.

Th irony, of course, is that a primary goal of any Premiership football team (usually packed to the gills with European imports) is to...wait for it....get into Europe, even as many (most?) of the fans chanting "we're all going on a European tour" support a Brexit.   Of course, a UEFA-sanctioned competition is a far cry from the European Union, so it's important to realize that this is just a jokey analogy.   Still, the backward step that English clubs took after being banned from European competition in the wake of the Heysel disaster in the mid-80's offers at least a modest reminder that going it alone is not all sweetness and light.

In any event, the swing in the polls and bookies towards "Remain", for whatever the reason, produced the predictable knee-jerk rally in sterling and risk assets.  Macro Man was gratified to see that the swing in cable was almost exactly what his simple model, presented here last week, suggested given the shift in interest rates and, more importantly, the decline in the Brexit odds from the bookies.

You have to say, however, that the price action in US equities at least was less than inspiring.   Sure, they closed higher on the day, but given the big gap opening higher for SPX cash to close up only 12 points was a bit of a disappointment.   For sure, the candle is not one that inspires a lot of confidence.  

With the bookies now making Remain three times more likely than Brexit, at this point you'd have to say that the balance of risk has tilted quite a bit in the last 72 trading hours.  At this juncture, a ten point swing in expectation is much more likely to have an outsized effect if it tilts towards Leave than towards Remain; after all, the latter is asymptotic at 100%, and there is the most "expectations gamma" around 50%, so any shift in that direction should have a bigger impact.     It was perhaps this realization that calmed the enthusiasm for equities as the yesterday's US session progressed.

Of course, there's also the small matter of Yellen's testimony today.  In normal circumstances, this would clearly be the dominant market-moving event of the next few days.   However, given that we had the FOMC press conference less than a week ago,  it seems a bit dubious that Yellen would drop any earth-shattering tape bombs, particularly ahead of the referendum.  Of course, you can't legislate (boom-boom) for the types of questions that she'll get from Congress, so it is of course still worth watching.

Perhaps one of the more perspicacious Senators can ask her how she's managed to be so effective for China....