Now that a second UK referendum appears to be out of the question and as a result there is no need to further punish UK risk assets in hopes of “changing people’s minds”, the risk on rally (especially with quarter end looming) can return, and so it has, with global stocks and US equity futures staging another surge overnight led by Japan (+1.6%) and China (+0.7%), and certainly Europe where moments ago the Stoxx 600 and Dax hit session highs, rising 2.6% and 1.9% respectively. The move has sent US futures higher by another 14 points, or +0.7%, to 2043, now up 44 points from Monday’s lows.

Best, however, is that the FTSE is now back to its post-Brexit highs, rising 2.5% so far today to just shy of 6,300. A few more hours of this ramp and UK stocks will recover all Brexit losses. At that point the scaremongering campaign can officially be called off.

This despite a warning from Credit Suisse that “the U.K. domestic sectors do not look cheap enough yet, with the exception of retailing. The trade and legal picture is very murky. The real hit to European growth if  there is another referendum (unlikely). The key is to watch PMI new orders to gauge the impact on corporate confidence”

Why the ongoing rally? A squeeze, sure, and also month-end fund flows. But the fundamental driver remains one and the same, and we quote Bloomberg:“the relief rally endures as Asian and European stocks rally with crude oil amid speculation policy makers will use stimulus to blunt the impact of the U.K.’s decision to leave the European Union, including a pause in the Federal Reserve’s tightening cycle. Investors are looking to policy makers for support.”

And confirming that it is all a bet on more easing, even gold was up today, while Japanese bond yields hit fresh record lows on expectations of more BOJ intervention. So once again, back to the old same old: hope that central banks will step in and once again expand multiples now that global earnings are set to decline once more courtesy of Brexit.

Not everyone is buying it of course: “While central banks assuring investors they’re ready to support the markets helps sentiment, it may be too early to turn optimistic,” said James Woods, a strategist at Rivkin Securities in Sydney. “We’ll probably continue to see heavy volatility. We’ll have to see what unfolds in the U.K. with the political situation after Brexit,” but for now the path of least resistance, not to mention short covering, is up and may well continue until the monthly window dressing process is concluded.

What else: the MSCI All-Country World Index headed for its highest level since before the Brexit vote and U.S. equity-index futures advanced as odds indicated the Fed is more likely to cut rates than raise them over the rest of the year. Sterling erased earlier losses, having rebounded in the last session from near a 31-year low. Oil climbed above $48 a barrel and gold approached a two-year high, while the dollar retreated against most of its major peers. Emerging-market stocks and currencies climbed for a second day. Bond yields in Portugal and Italy slipped, while those on Japanese debt fell to a record low.

The Stoxx Europe 600 Index climbed 1.9 percent, with banks and miners among the best performers. The equity gauge has recovered 4.6 percent after tumbling 11 percent over two days following the shock result of the U.K. referendum. It is still heading for a second quarterly decline. The FTSE 100 Index added 2.1 percent on Wednesday and is within 1.1 percent of its pre-Brexit close. Futures on the S&P 500 Index rose 0.7 percent after the U.S. benchmark jumped 1.8 percent in the last session, its best performance in almost four months. Nike Inc. slid 3.6 percent in early New York trading after its future orders missed estimates, renewing concerns that the world’s largest sports brand has entered a period of slowing growth.

EU leaders gather in Brussels on Wednesday for the second day of a two-day European Council summit to discuss Britain’s withdrawal from the bloc. They have already said that there can be no turning back for the U.K. and warned Cameron that delaying the period before formally activating the EU exit mechanism will prevent the start of negotiations over any future relationship. 

Also on today’s docket, we get the May personal income and spending reports, as well as the PCE core and deflator readings (the latter two are both expected to have risen +0.2% mom). Also due out today in the US is the May pending home sales report. Elsewhere, a number of ECB speakers are due to speak at the ECB forum in Portugal again today, while the Fed is also due to release results from the second part of its bank stress tests this evening.

Market Snapshot

• S&P 500 futures up 0.7% to 2043
• Stoxx 600 up 2.6% to 324
• FTSE 100 up 2.5% to 6296
• DAX up 2.0% to 9635
• S&P GSCI Index up 0.8% to 375
• MSCI Asia Pacific up 1.7% to 128
• Nikkei 225 up 1.6% to 15567
• Hang Seng up 1.3% to 20436
• Shanghai Composite up 0.7% to 2932
• S&P/ASX 200 up 0.8% to 5142
• US 10-yr yield down less than 1bp to 1.46%
• German 10Yr yield down less than 1bp to -0.11%
• Italian 10Yr yield down 2bps to 1.38%
• Spanish 10Yr yield down less than 1bp to 1.31%
• Dollar Index down 0.22% to 96.04
• WTI Crude futures up 1.3% to $48.49
• Brent Futures up 1.2% to $49.16
• Gold spot up 0.6% to $1,320
• Silver spot up 2.4% to $18.25

Top Global News

• Islamic State Blamed for Turkey Airport Attacks, 40 Killed: suicide bombers blew themselves up after police spotted them
• Cameron Makes Emotional Adieu as Sun Sets on U.K. EU Membership: British premier ‘genuinely sorry’ to bear Brexit news to EU
• Merkel Says No Way Back From Brexit as Cameron Regrets Loss: France says U.K. will have to ‘face consequences’ of exit
• Hollande Says Brexit to Hurt City of London in Clearing Warning: French Premier says City won’t be able to run euro clearing
• Fed’s Powell Says Brexit Shifts Global Risks Further to Downside: Powell says it’s far too early to judge effects of U.K. vote
• Victims of Brexit’s Real-Time Recession Already Feeling the Pain: hiring, expansion, investments all on hold after vote
• Who’ll Inherit Brexit? Tory Leader Candidates Break Cover: nominations to replace Cameron as premier open Wednesday
• Pound Records First Post-Brexit Gain as Historic Selloff Abates: sterling gets ‘brief reprieve,’ TD Bank’s McCormick says
• Editorial: British Parties Need to Move Faster to Choose Leaders
• Allergan Seeks Smaller M&A for Growth After Pfizer Breakup: CEO Brent Saunders spoke in Bloomberg TV interview

Looking at regional markets, Asia equity markets traded positive, following the US rebound in which the S&P 500 saw its largest intraday gain since March as energy was also bolstered. Nikkei 225 (+1.4%) shrugged off JPY strength and weak retail trade figures to outperform, while ASX 200 (+0.6%) was supported by gains in financials and after WTI climbed above USD 48/bbl. Elsewhere, Chinese markets complete the positive picture in Asia with the Hang Seng (+0.7%) conforming to the upbeat tone, while the Shanghai Comp (+0.3%) benefitted from another significant PBoC liquidity injection. Finally, 10yr JGBs traded relatively flat despite the heightened appetite for riskier assets in Japan, as the BoJ were in the market to acquire JPY 1.15trl in government debt.

Top Asian News

• Nomura Joins Yen Capitulators as Forecast Raised 17% Post- Brexit: Japan’s biggest brokerage now sees 104 per dollar at year-end
• Offshore Yuan Surges on Bets Central Bank Supporting Currency: Nation will take steps to ensure market stability, Premier Li says
• Ex-Lehman Quant Wins Big on Bad China Loans That Scare Soros: Distressed debt investors buy as NPLs climb to 11- year high
• Hong Kong’s ‘Superman’ Li: My Empire Will Be Fine Without Me: Billionaire Li Ka-shing talks about not slowing down
• Wanda Property Deal Faces Hurdles as APG Balks Over Price: $460b Dutch fund manager says Wang’s offer is too low

European equities trade higher for a second day, with notable upside in material and financial names, allied with this, equities are likely to benefit from month-end rebalancing, according to Goldman Sachs . Additionally, peripheral banks continue to outperform in a similar fashion to yesterday relative to the heavy losses seen on Friday and Monday post the Brexit vote. Elsewhere, credit markets have been somewhat tame this morning as the German 10-yr benchmark trades in tight range with yields across the curve relatively unchanged, while peripheral yields continue to tighten amid the risk on sentiment.

Top European News:

• Vodafone Weighs Post-Brexit Move as CEOs Seek Europe Access: ‘not yet possible to draw any firm conclusions’ on HQ location
• Ikea Recalls 29 Million Dressers After Six Children’s Deaths: 82 incidents are also linked to tip-over risk with furniture
• Homeserve Confirms it Continues to Trade in Line With Guidance: maintains long term expectation of achieving a 20% margin in U.S. business
• McCarthy & Stone Says Brexit Vote Has Introduced Uncertainty: may hit timing, cost of conversion of orders into completions
• Swiss Re Sees Life Premium Growth in ’16, Slowdown in Em. Mkts: sees continuing pressure on non-life

In FX, the Bloomberg Dollar Spot Index slid 0.1% following a 0.5 percent loss in the last session, amid speculation about the path of Fed interest rates. Sterling advanced for a second day against the dollar as investors await Britain’s plan for its extrication from the 28-nations bloc. “Markets have calmed down somewhat,” said Thu Lan Nguyen, a foreign-exchange strategist at Commerzbank AG in Frankfurt. “We may see some short term continuation of the recovery in the pound if there is an increased chance of a new prime minister who can secure the access of the U.K. to the single market. But uncertainty is still high and market participants are jittery.” The yen rose 0.1 percent following a 0.7 percent decline on Tuesday. Nomura Holdings Inc. became the latest brokerage to raise its year-end forecast for the currency and now expects a 17 percent increase after the U.K.’s decision to leave the EU spurred a rush for it as a haven. The MSCI Emerging Markets Currency Index added 0.5 percent. South Africa’s rand led the advance, rising 1.1 percent, followed by a 1 percent gain in South Korea’s won. Indonesia’s rupiah added 0.1 percent, extending this week’s increase to 1.6 percent and heading for the highest close in two months. The central bank said it will intervene in the foreign-exchange market to prevent the rupiah from gaining too much from a possible increase in inflows following a recently passed tax amnesty law. The offshore yuan strengthened for the first time in five days, gaining 0.3 percent in just over an hour. Chinese authorities intervened via banks to support the offshore yuan in morning trading, according to people with knowledge of the matter. The People’s Bank of China didn’t immediately respond to questions sent by fax from Bloomberg.

In commodities, the Bloomberg Commodity Index extended Tuesday’s 1.9 percent rally with a 0.3 percent advance. Gold recovered most of the previous session’s losses, adding 0.5 percent to $1,318.62 an ounce on speculation that the Fed’s interest rate policy will boost the precious metal’s allure. West Texas Intermediate crude climbed 1 percent to $48.35 a barrel, building on last session’s 3.3 percent jump. U.S. oil inventories fell by 3.86 million barrels last week, the American Petroleum Institute was said to have reported, ahead of government data due on Wednesday. Cotton futures for December delivery rose 0.4 percent to 66.1 cents a pound on ICE Futures U.S. in New York. Prices extended Tuesday’s 2.3 percent rally and are trading near the highest since August 2015. U.S. farmers probably planted fewer acres than previously expected, after rain disrupted fieldwork in some areas, according to a Bloomberg survey before the U.S. Department of Agriculture updates its estimate on Thursday.

Bulletin Headline Summary from RanSquawk and Bloomberg

• European equities enter the North American crossover in positive territory with energy names leading the way higher following last night’s API draw
• Following on from the calm seen on Tuesday, FX markets have again displayed a propensity towards steady risk sentiment, with the commodity currencies faring well in particular
• Looking ahead, highlights include US Pending home sales, PCE’s and DOE’s, ECB’s Draghi (Dove)
• Treasuries mixed in overnight trading with long-end outperforming as global equities and gold rally on potential for monetary stimulus.
• European Union leaders said there could be no turning back for the U.K. after Prime Minister David Cameron used his last EU summit to express disappointment at his failure to win the referendum he called on Britain’s membership
• Brexit has thrust Scotland’s independence back into play just two years after the nationalists suffered defeat in a referendum to leave the U.K.
• The City of London is facing the first direct threat to its role as Europe’s dominant financial center as French President Francois Hollande takes aim at a key pillar of the U.K. industry
• France’s 2017 presidential election may hinge on a debate about the European Union membership in the aftermath of the U.K. vote to leave the bloc, President Francois Hollande said
• By voting to leave the European Union, Britons have delivered a potential windfall to tourists eager to snatch up Burberry trenchcoats, Harrods Stilton and Liberty scarves on the cheap
• Gold’s investment case has been strengthened by the U.K.’s vote to quit the European Union as the fallout may spur the world’s central banks to step up easing, hurting currencies and favoring bullion, according to Marc Faber
• Circle Jan. 31, 2018, on the calendar. That’s the soonest the Federal Reserve hikes next. At least if money market derivatives are to be believed.
• The number of Chinese bond defaults so far this year already is triple the figure for all of 2015. The number of downgrades has also tripled
• The PBOC intervened via banks to support the offshore yuan in morning trading as authorities wants to maintain stability in the currency, according to people with knowledge of the matter
• Puerto Rico and its agencies are facing $2 billion of bond payments due Friday, and Governor Alejandro Garcia Padilla has said the U.S. territory simply doesn’t have the money

DB’s Jim Reid concludes the overnight wrap

Markets yesterday were certainly in a much improved mood as a tentative rally swept through risk assets following two days of heavy losses. Look no further than the Pound which closed up +0.90% versus the US Dollar at 1.3344, although it did actually tip above 1.340 in the early afternoon before paring gains again into the evening. Equity markets emerged from the abyss meanwhile. The FTSE 100 (+2.64%), Stoxx 600 (+2.57%), DAX (+1.93%), IBEX (+2.48%) and FTSE MIB (+3.30%) all closed up as beaten down banks staged a recovery. Indeed UK financials had a much better day although that was before Moody’s made the move to revise lower its outlook on 12 British banks and lenders, as well as cutting the outlook for the UK banking system to negative from stable.

Across the pond the S&P 500 closed up +1.78% which was actually the most since March 1st. Credit markets were in a similar vein of form with CDX IG rallying 6.5bps. Interestingly primary markets appeared to get the green light for the door to open again. Molson Coors was out with a four-tranche $5.3bn deal which is said to be the first US IG deal since the referendum last week. Notably the deal was said to be 6x oversubscribed so a good sign that appetite is still clearly strong for those with cash ready to be put to work.

The other news to report this morning is the tragic event which unfolded in Turkey last night where a suicide attack at Istanbul’s main international airport has resulted in the death of at least 32 people, with a further 60 people said to be injured according to the BBC. Details are still sketchy but we’d expect further information to be released in due course.
That news emerged towards the US close last night and markets wise we’ve not seen too much of a reaction in Asia this morning. The bulk of bourses are instead following the lead from the European and US sessions yesterday. Leading the way is the Nikkei which is currently up +1.44%, while the Kospi (+1.39%) is closely following. The Hang Seng (+0.69%), Shanghai Comp (+0.45%) and ASX (+0.92%) are also up while credit markets are generally 2-3bps tighter. FTSE 100 futures are currently up over 1% too while Sterling is -0.20% weaker as we type.

Yesterday’s economic dataflow didn’t add too much to the debate. In the US the third reading for Q1 GDP was revised up to +1.1 qoq from +0.8% which is a touch better than expected helped by stronger net exports, although consumption did disappoint a little. The upward revision to corporate profits caught our eye however, with profits revised up to +1.8% qoq from the previously reported +0.3% qoq gain. Meanwhile, also better than expected was the June consumer confidence index reading which printed at 98.0, a rise of 5.6pts from May after expectations had been for just a 1pt rise. That reading is actually the highest level since October last year although clearly it’s worth taking with a pinch of salt given the cut-off data for the survey was June 16th and a week prior to the UK referendum. Elsewhere, the Richmond Fed manufacturing PMI was disappointing at -7 (vs. +3 expected), a fall of 6pts. Lastly the S&P/Case-Shiller house price index in April rose slightly less than expected during the month at +0.45% mom (vs. +0.58% expected).

Looking at the day ahead, we’d imagine that much of the focus will again be at the EU Leaders summit in Brussels which continues for a second day. Datawise we’ve actually got a fair bit to get through. This morning in Europe we’ll get the latest consumer confidence report for Germany, as well as house price data in the UK. Later on we then get the money and credit aggregates numbers in the UK before the June confidence indicators for the Euro area are released. This afternoon we’ll firstly get the June CPI report in Germany, before attention turns across the pond where we will get the May personal income and spending reports, as well as the PCE core and deflator readings (the latter two are both expected to have risen +0.2% mom). Also due out today in the US is the May pending home sales report. Elsewhere, a number of ECB speakers are due to speak at the ECB forum in Portugal again today, while the Fed is also due to release results from the second part of its bank stress tests this evening.

Submitted by Olav Dirkmaat via UFM Market Trends,

The delinquency rate on loans is key in understanding banking. It answers one question: what percentage of loans is overdue for payment? The delinquency rate is by far the most useful indicator for “credit stress.” It seems, however, as if delinquency no longer counts. Few are paying attention to the quick and sudden rise of the delinquency rate. What does it tell us and is a new banking crisis imminent?

This Is What Happened after Janet Yellen Hiked the Fed Funds Rate in December

I have said it many times over and I will repeat it here: the last time around, it took Fed-chairman Alan Greenspan over two years and seventeen rate hikes to bring the Fed funds rate from a then all-time-low of 1% to 5.25%, before the U.S. economy suffered the worst recession since the 1930s. We are not so lucky this time.

Greenspan’s rate hikes didn’t affect delinquency rates straight away. Credit stress was subdued until a year after Greenspan’s last hike. Only in the first quarter of 2007, delinquency rates began to move higher. The reason is as clear as the water surrounding the Bahamas: in the years preceding the Great Recession credit growth was mainly focused on the U.S. housing market.

Credit growth was mostly driven by mortgage lending. Mortgages were generously provided by banks, but increasingly to subprime borrowers (subprime referring to their poor credit). Yet these subprime borrowers didn’t pay higher interest rates on their mortgages the moment Alan Greenspan began hiking rates. But as soon as their (promotional) teaser rates resetted, they started “feeling the Alan.” Delinquency rates went through the roof and the U.S. economy into recession.

Teaser rates, the low initial interest rate a borrower pays for the first few years, were responsible for the lag between Greenspan’s rate hikes and the 2008 recession.

More Fragile

Today, the Federal Reserve is ignoring a very inconvenient truth: the global economy is much more fragile than the last time around. And we have no teaser rates in today’s subprime credit (unless we of course consider oil producers that hedged oil prices by buying futures as something akin to “teaser rates”).

This time around, we will certainly not need seventeen rate hikes or three years before pushing the economy into recession.

In fact, we now know what happened after Janet Yellen increased the Fed funds rate with a mere quarter-percentage point: the delinquency rate on commercial and industrial loans increased 50%. That is right. In a single quarter delinquency rates in the U.S. banking sector exploded from 1% to 1.5%. The cycle has turned.

This Is Why Nobody Is Paying Attention

Why is nobody paying attention to this seemingly undeniable shift in the credit cycle? Why does the Federal Open Market Committee (FOMC) not even mention it? Why are the alarm bells not ringing in both Fed board rooms and the financial press?

The only answer to these questions is that the Fed is committing a capital sin. The headline number, the delinquency rate on all loans, decreased in the first quarter of 2016 from 2.20% to 2.17%. That ignores, however, the underlying pressures building up inside banks’ balance sheets. Fed-officials seem to focus on the headline number, while ignoring the deteriorating fundamentals.

With rising home prices, a vibrant housing market, increasing employment and interest rates at the lowest levels in world history, defaults on mortgage and credit card debt are reaching all-time lows. Yet delinquency on mortgages and credit cards tend to lag the business cycle. Typically, they only rise when we already are in recession, just as unemployment tends to be a lagging indicator.

^{The headline number is fooling Fed-officials; delinquency rates are still declining. But the delinquency rate on all bank loans (the headline number) has no predictive power; it just follows a random pattern. Source: St Louis Fed}

Even if we are on the verge of a new banking crisis, the headline number will never tell us so.

Which Loans Are Increasingly Overdue?

If delinquency rates on consumer credit (mortgages and credit card debt) will not help us in estimating how probable a new banking crisis is, then which delinquency rates do matter? And why did I call them “shocking”?

Let’s first break down a bank portfolio. Bank loans can we divided into three groups:

• Consumers
• Businesses
• Real estate (both commercial and residential)

(Just for the sake of comparison, U.S. banks currently hold $1,300 billion in consumer debt, $1,810 billion in commercial and industrial debt, and over $3,000 billion in real estate debt.)

Banks lend money to consumers for buying homes (mortgages) or consumer goods (credit card debt). We concluded that delinquency rates on those loans tend to lag the business cycle.

What’s left?

Loans to businesses, in whatever form or shape they come. Most of these loans are pegged to an interest rate benchmark, for instance the LIBOR. After the Fed’s first rate hike in December, the U.S. dollar 12-month LIBOR went up from approximately 0.8% to 1.3%. Marginal borrowers are slowly getting pushed into bankruptcy.

December’s rate hike clearly resulted in a change of tides: delinquency rates have bottomed and are on their way up. And do not forget the following: the fact that delinquency rates no longer decrease but began to increase, has always been a clear warning signal for a recession — at least during the past twenty years. And over that same period, this indicator never gave a “false positive,” in contrast to many other (recession) indicators.

^{A clear danger sign: delinquency rates on commercial and industrial loans are creeping up. Source: St Louis Fed}

^{In dollar terms the shift is even more pronounced. This is of course the result of our staggering debt levels, which are not apparent in the relative numbers. Source: St Louis Fed}

^{In line with increasing loan delinquencies, charge-off rates on commercial and industrial loans are picking up as well (charge-off rates tend to lag somewhat). Source: St Louis Fed}

Delinquency Rates in Europe

The delinquency rate in Europe is also on the rise. Yet, we do have to single out the countries that skew this eurozone average. Italian banks in particular are suffering from an unbelievably high delinquency rate. The delinquency rate in Italy is at such extreme levels that the country might turn the euro crisis in front page news again (if for once Greece remains on the sidelines).

^{The delinquency rate on bank loans in Europe is also on the rise; here too, at least in the periphery countries, it appears the credit cycle has turned. Source: European Central Bank (CBD2, ‘gross non-performing debt instruments’)}

Keep a Close Eye on Delinquency

What is next? We will have to wait and see to find out what delinquency rates have done in the second quarter. However, it is clear that the tide has turned. It is irrelevant whether the Federal Reserve will hike rates in July or September. Consensus currently says we should expect two more rate hikes this year. If that is true, we can expect delinquency rates to move up further in the coming quarters.

In 2006 it was exactly twelve months after delinquency rates bottomed that the recession began. If the same period applies, we are due for a recession. In the first quarter of the Great Recession in 2008, delinquency rates were only 1.45%. We are already above that level. On the flipside, however, we should not ignore that it took three years of rising delinquency rates before the economy entered into recession in 2001. Credit cycles are not an exact science. Yet the trend is clear and Fed chair Janet Yellen should be terrified about this disturbing development.

The fact that increasing loan delinquency coincides with mountains of debt maturing in 2016 and 2017 is a topic for next time.