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    A brief survival guide to trading FX during Brexit

    Next week’s UK referendum on EU membership will be the defining risk event of the first half of the year.  As such, market participants are readying themselves for a week of volatility and big moves in major asset classes and across financial markets.  Central to this is Foreign Exchange, which is the world’s largest and most liquid market.  Therefore, traders may find useful some suggestions of how markets might react in either a “leave” or “remain” outcome.

    First of all, at the risk of stating the obvious, in the event of “leave”, sterling should be down by between 5% and 15% – depending on the currency against which it is paired.  The losses are expected to be the biggest against the yen, while smaller losses should be recorded against the euro and perhaps the Australian dollar.  The aussie is after all a currency that can be hurt by risk aversion and negative risk sentiment is certainly what Brexit is expected to bring.  Somewhere between the two extremes of the yen and euro will probably be sterling’s reaction versus the US dollar.  In the event of “remain”, one should expect the mirror image of these moves, but on a certainly smaller scale as on balance the market seems to price a “remain” vote as more likely than a “leave”.  This will also depend of course on the market moves during the days immediately preceding the referendum.  If the movement in odds continues to favor the “leave” camp for example, the market should shift ahead of the referendum.

    The second currency that will be examined is the euro.  The euro is expected to be hit by a “leave” vote, as more doubts will emerge about the European project and possibly reignite doubts about the future of the euro itself .  The euro’s woes will be significantly less than those of the pound and the euro should climb versus the pound – most probably between 80 and 85 cents.  The euro should also sink below 1.10 against the dollar while the yen should also extend its recent streak of multi-year lows for euro / yen.  One possible reason for euro weakness is that due to the financial linkages between the UK and the Eurozone, the ECB might be forced to take some kind of emergency action to help the region’s financial institutions, which in turn should weaken the euro.  If “remain” wins, a significant part of euro / yen’s recent losses should be reversed, while the euro might find itself pushing at the upper bound of its recent range against the dollar at 1.15.

    Moving on to the yen, the currency’s strength has certainly caused quite a headache for the Japanese government and the country’s exporters.  The possibility of a “leave” vote resulting in further yen appreciation will be particularly distasteful to Japanese policymakers.  While the yen has been the currency that has benefitted the most from Brexit uncertainty, should dollar / yen drop further and particularly cross below the 100 mark, Japanese authorities may feel compelled to act.  Therefore, even a ‘safe haven’ choice presents the major risk of hitting against the wall of central bank intervention.  This same argument can be made for the Swiss Franc, although its recent gains have been much more contained than the yen.  The Swiss National Bank again expressed concern about the overvalued franc today and will probably not hesitate to intervene in order to dissuade speculators from piling long positions in the currency in the event of Brexit.

    Intervention risk for the Swiss Franc and the yen probably leaves precious metals and long-term government bonds as odd bedfellows as the candidates for the ‘least risky’ safe havens if things take a turn for the ugly post-Brexit.  The US dollar might also do ok, as the world’s reserve currency might be in demand in such circumstances, despite the relatively dovish tone of the FOMC statement and Chair Yellen yesterday.  Precious metals such as gold should have more upside compared to certain government bonds (how much more negative can Japanese and German government yields go?), but gold will certainly have more downside risk if things look like calming down following a “remain” vote.

    Commodity currencies such as the Australian, New Zealand and Canadian dollars, might at first glance appear far removed from Britain’s and Europe’s woes.  However, if Brexit sparks widespread risk aversion, these currencies should also follow risk assets lower.  Risk aversion may also hit the oil price, as slower global growth might reduce demand for energy.  On the other hand, if the risk of Brexit is overcome, that will lift a source of uncertainty for markets and this could benefit risk assets and commodity currencies.  The impact on these currencies in the case of a “remain” vote might not be that significant however – just moderate gains.

    Finally, it should again be kept in mind that it is not only the first hours following the announcement of the referendum result that will be critical but the days after that as well.  It remains to be seen for example whether the deep political splits that have been created by the referendum will heal easily or whether they will continue and cause further political turbulence in the UK – whatever the referendum result.  Having a plan in place and managing risk well will be very key next week for investors, traders and other market participants.

     

     

    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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