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    Sterling and euro united in pain amid rising Brexit fears

    The pound and the euro under pressure

    The pound was under severe pressure at the beginning of the week after the Mayor of London, Boris Johnson, an important member of the ruling Conservative party’s leadership, decided to take a stance against the position of the leader of his own party, Prime Minister David Cameron.  Specifically, Boris Johnson said he would back the “Leave” campaign on the upcoming June referendum for Britain’s EU membership.

    In hindsight, as Britain’s conservatives have been fighting amongst themselves for decades on the subject of European Union membership, this should have been expected.  It should also be remembered that the two previous Conservative Prime Ministers Margaret Thatcher and John Major, were more or less ousted by their own party partly because of intense infighting on European integration.  Therefore this referendum may have some broader negative implications for political stability in the UK as it might split the ruling party in two.  It is also assumed that if the current Conservative government loses the referendum, it will resign and new elections will be held shortly.  In this way, a win by the “leave” campaign is going to result in plenty of uncertainty – both with respect to the future government of the country as well as the fact of course that the exact Brexit terms cannot be known in advance.

    One should not get carried away at the same time, as it appears more likely that the “stay” campaign is going to win.  The “leave” campaign’s chances of winning are not negligible (around 30%), but investors should be careful during the referendum-related volatility so as not to overreact and get caught up in the latest headlines.  Such behavior was clearly on display both last Friday when the pound rallied due to the deal the UK struck with the rest of the EU, as well as on Monday when London’s Mayor said he would back the “leave” campaign, causing sterling to crash.

    Another ‘victim’ of the Brexit debate appears to be the euro.  The currency has had some problems of its own in the sense of weak recent business confidence surveys, but worries about Brexit and how this could affect the EU ex UK organization were seen pressuring the single currency as well.  The upcoming ECB March meeting is a key risk event for the euro as Draghi has signaled that he may add to existing stimulus by cutting interest rates even further into negative territory and perhaps augmenting the QE program.

    Both sterling and the euro were under pressure – particularly against the dollar and the yen.  Against the yen the euro fell to its lowest in almost 3 years while the single currency was struggling to hold on to the 1.10 level against the dollar.  Similarly, the pound hit a near 7-year low versus the dollar and was holding on to the psychologically important 1.40 level for now.

    The pound and the euro have another characteristic which may cause some problems.  The two currencies (and economies) are perhaps more sensitive to fluctuations in global economic growth (Eurozone’s export sector) and global financial conditions (UK’s financial sector).  Therefore slower global growth or more market turmoil could be bad news for the two economies.  Both the global economy and global markets are facing some challenges this year.

    Risk-on faces a test

    It was also noteworthy that US stock market performance, as measured by the benchmark S&P 500, continued to do well following a very positive previous week.  On Monday the S&P 500 closed within a hair’s breadth of the early February high of 1947 (the index closed at 1946).  If that particular high is taken out, the S&P will climb to its highest level since the first week of 2016.  Stocks were helped by optimism that oil prices have found a floor as US shale oil producers curtail output and the deal to freeze production between Russia and Saudi Arabia is seen in a favorable light by other key producers.

    Again it should be pointed out that the recovery in risk appetite has done little to hurt the yen’s allure as one would normally expect.  Dollar / yen briefly dipped below 112 again, as it had done before the S&P recovered during the previous week (when it was trading in the 1800s).

    Another point that may prove problematic for stock bulls is that at the current juncture, the rush of the stock market to recover in combination with decent US economic statistics, could convince the Fed to revert to its original plan of delivering three or four interest rate hikes this year.  Therefore, the continuation of the rally in stocks could carry with it the seeds of its own demise in terms of more rate hikes by the Federal Reserve (which stocks dislike).  It will be very interesting how the theme of monetary policy normalization combined with financial conditions will play out in the coming months.

    Risk Warning: Forex, Commodities, Options and CFDs (OTC Trading) are leveraged products that carry a substantial risk of loss up to your invested capital and may not be suitable for everyone. Please ensure that you fully understand the risks involved and do not invest money you cannot afford to lose. Please refer to our full Risk Disclosure.

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