Macquarie Equities Research (MQ Research) released a series of reports on Friday after the shocking Brexit event became a reality.  The UK voted in Thursday’s referendum to end its 43 year membership of the European Union (EU) with the leave side taking 52% of the vote.
 
Global indexes around the world plummeted on Friday in a knee-jerk reaction to the news. The Hang Seng Index shed 2.9% or 609 points, whereas the local bourse hit an intraday low of 1,611 before recovering back to 1,634, down 0.4%. 
 
In the report below, MQ Research delayed their forecast for a US rate hike to December, after the recent shock to the market.  Read on for excerpts…
 

• MQ Research has push out their base case for an FOMC hike following the UK vote to leave the EU. MQ Research now sees a hike as most likely in December. MQ Research’s updated probability distribution is July (0%, prev. 25%), September (20%, prev. 45%), December (50%, prev. 20%), later than December (30%, prev. 10%). This shift reflects uncertainty on how the Brexit vote may impact the broader global outlook. MQ Research’s Europe economist, Matthew Turner, anticipates considerably lower growth in the UK in 3Q due to weaker business investment and consumer spending.

• From the Fed’s standpoint, the magnitude of the impacts certainly won’t be clear before July’s meeting. It is also unlikely (although possible) that there will be full clarity before September. Given Chair Yellen’s emphasis on the asymmetries to the policy outlook when the Fed Funds rate is so close to the zero lower bound, odds are that the committee will err on the side of showing caution and patience. Should impacts on financial markets and the global outlook persist and remain cloudy, the longer the likelihood that the Fed remains on pause.

• MQ Research caution on over-reacting too much to the impact of the vote. Like MQ Research’s Australian Macro team, MQ Research believes it is unlikely to turn into a Lehman-like moment. The US economy is relatively well insulated from global weakness. In particular, the key drivers of growth are domestically driven, residential construction and consumer spending (particularly on services). Also the drag on activity from declining energy investment is now in the rearview mirror.

 
Rising and healthy inflation a key part of our outlook

• Another key component to the policy outlook is the return of healthy inflation. There are growing signs that pressures are rising. Two leading indicators MQ Research tracks closely, the median consumer price index (CPI) and the sticky price CPI reached 2.5% and 2.6% YoY respectively in May. Moreover, the USD and the oil price are set to shift from being headwinds to inflation to tailwinds in the very near term
• Underlying pressures are likely to also be fueled by improving wage growth. Should the monthly pace of YTD gains continue in average hourly earnings growth, this measure will exceed 3% YoY by December. An alternative indicator that is not impacted by elevated retirements, the Atlanta Fed’s median wage growth tracker, is already at 3.5% and shows an even stronger pace (4.3%) amongst job switchers. Combined with growing signs that a modest releveraging is here, this suggests inflation may surprise on the upside through year-end, particularly given the low threshold in the FOMC’s current end-16 projections (1.4% and 1.7% for the headline and core PCE price indices).

• Some may see a hike as unlikely in 2016 because of the impact that it could have on financial conditions and the USD, but the longer the FOMC waits ahead of hiking (and the more that inflation moves higher), the less the impact rate hikes are likely to have on the dollar, particularly should the Fed (as MQ Research’s expects) maintain its approach of hiking rates only very gradually and cautiously.

 
MQ Research’s outlook of resilient US growth, a healthy improvement in inflation, and gradual rate hikes is positive for US equities. MQ Research sees weakness emanating from Brexit concerns as a buying opportunity.
 

Source: Macquarie Research - 27 Jun 2016