For the past 6 months investors have been waiting with bated breath for the UK’s EU referendum. We are now less than 4 days to the vote and no closer to clear majority. Last week’s tragic killing of Jo Cox, the UK member of Parliament shows how the amount of passion and anger around the issue can radicalize extreme voters. It was the closeness of the votes that led both sides to escalate their language ahead of referendum but even with the murder of this pro-EU British campaigner and ensuing sterling recovery, bookies still put the odds of Brexit at just under 40%. These numbers show that the Leave campaign has successfully tapped into the country’s growing frustration with immigration but Brexit has significant consequences that will rip the British pound and the European Union apart. It is estimated that sterling will fall as much as 10% or approximately 1400 pips and the economy would shrink by more than 3% over the next 3 years. In fact her Majesty’s Treasury estimates a 7.5% contraction over 15 years. These projections may be over exaggerated but the consequences are significant on both a short and long term basis. S&P warned that Britain could lose its AAA rating and the seamlessly renegotiated trade pacts may not come easily as EU nations retaliate. Multinational corporations will look to move its European headquarters from London to Frankfurt or another major hub on the continent. While a Britain free from the EU would be able to set its own regulations, it is foolish to think that it won’t be influenced by its desire to cooperate with a region that takes 45% of British exports.
As currency traders, our focus is on the short to medium term market impact of the EU referendum. First let's start with pre-Brexit trading – while many traders believe that the high degree of uncertainty will drive sterling to trade lower in the days ahead of the vote, we need to warn our readers about the risk of a short squeeze. Sterling has fallen significantly over the past month and with most forex brokers raising their margin requirements ahead of the referendum, it creates strong motivation for traders to take profits ahead of such a significant event risk. The Swiss National Bank’s decision to abandon their EUR/CHF peg is still fresh on everyone’s minds and the potential for a more than 400-pip swing in either direction may be too much for leveraged traders.
On the day of the referendum, the votes will trickle in slowly. At some point, a majority will start to form and if you’re following the poll results on twitter and have fast fingers, you may be able to join the move for 100 to 200-pip profit. The gains will be sustained and likely to turn into a steady 4 to 5% recovery for sterling if Britain decides to remain in the European Union. However if they decide to Leave trading will be very messy. A Leave vote could trigger a 4 to 6% knee jerk decline in sterling but watch for a significant V shaped recovery if lawmakers try to calm the markets by saying that all remains the same until the terms of Brexit are negotiated – which could take months or possibly even years. But any intraday recovery will be short-lived as investors view Brexit as a major mistake that will cost Britain its position as the region’s financial and corporate hub.
Good trades.
