Forex Market News | Saturday 18th June, 2016
In less than a week, citizens of the UK will make their biggest decision in more than a generation when they go the polls to vote on whether to stay in the European Union (EU), or to leave it. It’s conceivable that the political and economic future of the entire 28 member EU could be reshaped by the June 23rd referendum.
Those in favor of leaving the EU, known as the “Brexit” option, say EU elitist rules restrict UK companies and leaving would boost the UK economy. They also say that leaving the EU would give Britons control of their borders and limit immigration. Those campaigning to stay (including the PM David Cameron) paint a very grim picture of life outside the EU.
The result of the vote could have acute and far reaching consequences not just for the British and EU economies, but also for global FX markets and G-7 stock markets in particular. At this point, the polls suggest that UK voters are spilt down the middle without an outright majority on either side. Further, it seems the only clear consensus is that a win for the Brexit camp would reshape the future of the UK and EU for decades to come … the problem is that nobody knows exactly how.
Regular readers of the Synergy FX Forex Market News have noticed that we haven’t made any specific trade suggestions for the GBP/USD over the last 10 trading sessions. And have also noticed that we focused last Monday’s report on how the uncertainty of the referendum outcome is spilling away from the GBP/USD and now impacting all the major currency pairs.
As such, we have been overwhelmed by traders and investors alike who only want the answer to one question: How can we make money on the Brexit vote?
To address this question accurately, we believe it’s important to look at some of the basic dynamics of the “cause and effect” aspect of how the market is pricing risk in the GBP, as well as the other major pairs.
The prevailing opinion strongly suggests that a Brexit victory would hammer the Sterling lower against all currencies, especially the USD. The reason for this is simple. The UK has a historically large current account deficit of £ -33 billion which is expected to expand rapidly if the UK leaves the EU due to the uncertain future of trade agreements and capital inflows, which could push the GBP down 10 to 15% over the next six months.
Other economists have predicted job losses of up to 800,000, a collapse of the UK housing market, massive capital outflow and EU based banks closing operations in the City of London.
When assessing the probability of these outcomes, it’s important to note that many of these forecasts for economic Armageddon in the Old Dart come from the same research teams who failed to identify that 100% financed, negatively-amortized mortgages on overpriced US real estate could lead to the Global Financial Crisis in 2009.
In other words, the UK referendum is an unprecedented market event; and there is no historic point-of-reference from which a entirely accurate “cause and effect” trading protocol can be drawn. Which means increased volatility, wide price spreads and potential liquidity gaps can be expected regardless of the result of the vote.
It’s likely the process of the vote and how the ballots are counted could contribute to market volatility. According to the UK Electoral Commission, each of the 382 counting districts will be open from 6am to 9pm LDN time. There are currently no plans for broadcasters to announce exit polls as the “margin of error” is deemed too large. The ballots will be counted between 10:30 and 4am LDN time with the final announcement expected by 6am on June 24th.
If, in fact, there are no exit polls to guide FX investors’ expectations during the day and throughout the ballot counting process, making money on the final referendum result becomes a simple (but potentially costly) “Red or Black” proposition; with open positions either making a bundle or getting stopped out with hefty losses. .
We can also imagine that the strategy of leaving resting orders above or below the market wouldn’t work either; as dealing spreads widen and liquidity dries up leading into the announcement of the final result.
On balance, our base case going into referendum is the same as its been for the last 10 trading days: stay on the sideline, protect your equity and wait for a clear signal to emerge.