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FX Technical Analysis (2016-06-27)

by James Chen

Fundamental Recap: Brexit Outcome Stuns Markets – What Comes Next?

The outcome of Thursday’s historic EU referendum, in which nearly 52% of UK voters opted to leave the European Union, stunned markets globally in its immediate aftermath on Friday morning. The vote counting began with a surprisingly sizeable lead for Leave at over 60% of voters in Sunderland, and the pro-Brexit camp never looked back as it continued to maintain a modest advantage throughout the vote tally, even after the expectedly pro-Remain London votes came in.

Prior to the voting results being known, most of Thursday and the previous several days were characterized by the financial markets’ strong conviction that Remain would prevail. Despite an extremely tight contest in pre-vote polling, this was partly due to betting odds-makers predicting an overwhelmingly high probability of a Remain victory. To say that financial markets were caught off-guard when the Leave camp began early in the vote count to show its strength would be an understatement. After the referendum’s outcome, when UK Prime Minister David Cameron announced his upcoming resignation as a result, the market impact was even more pronounced.

As it became increasingly clear during the vote count that a Brexit outcome might actually occur, markets experienced exceptionally high volatility, most notably in the currency markets. In particular, the British pound and Japanese yen underwent vast and rapid swings throughout the course of the vote count. As expected, the British pound was most heavily pressured due to the widely-projected, negative economic implications of a Brexit, with GBP/USD plunging at one point to more than a 30-year low of 1.3226 in the aftermath of the referendum outcome. Also as expected, the Japanese yen surged strongly due to its status as a safe haven currency in times of market turmoil, with USD/JPY dropping to a new multi-year low just below 99.00.

When the pound and yen were pitted against each other in the form of GBP/JPY, the results were even more dramatic. The currency pair dropped by a massive 20 big figures to a new 3½-year low just above 133.00. Finally, although the euro rose sharply against the even more heavily-pressured pound, the common currency had its own fair share of trouble after the referendum results. EUR/USD plunged to a low of 109.10 before paring much of its losses on Friday morning.

The market impact was not limited to currencies, however, as gold spiked due to its status as a safe haven asset and global equities experienced large initial drops on the news. By Friday afternoon in Europe, most of these reactions had been cut back significantly, but exceptional pressure on sterling continued to define the financial markets.

Now that the news is out and the immediate market reactions have occurred, what might be next with respect to the Brexit outcome? The process of separation between the UK and European Union is expected to be long and drawn-out, likely taking at least a couple of years with many negotiations, both political and economic, occurring in the process. On the near-term horizon, however, Brexit implications will probably be felt relatively quickly and on a global basis. The obvious question now is which EU countries might be next in holding their own referenda for leaving the European Union. If this becomes an increasing occurrence amongst current EU countries, the viability of both the European Union and the Eurozone (and in turn, the euro currency) could become even more questionable.

But even more pressing at the moment is Brexit’s potential impact on major central banks. Bank of England Governor Mark Carney made a televised appearance on Friday morning stating that the central bank “will not hesitate to take measures as required” with respect to the extreme volatility in the pound as a result of the referendum. The other major currency most affected by Brexit, as noted, has been the Japanese yen. There have been numerous warnings in the recent past and the immediate run-up to the referendum from Japanese officials touting Japan’s readiness and willingness to intervene should the yen become too strong or experience exceptional volatility. If the yen spike continues, given that the USD/JPY dropped well below 100.00 at one point on Friday, this could very well fulfill the prerequisites for an impending currency intervention by Japan in attempts to stem the yen’s rise.

Finally, the Brexit outcome is very likely also to have a substantial impact on the US Federal Reserve. Since the results of the referendum have been announced, the implied probability of a Fed rate hike any time this year has plunged dramatically, with some market participants now even speculating on a possible rate cut. If this actually comes to pass, the Fed will have finally relented by joining other major central banks on the prevailing global trend of monetary easing.

As the Brexit outcome continues to be digested through the next few weeks, the markets should continue to exhibit lingering volatility as the trends going forward are being determined. For both the pound and euro, this could mean persistent pressure for the time being, particularly for the euro if other EU countries begin to take the UK’s lead. Safe haven assets like gold, the yen and the Swiss franc, should also remain supported as markets fluctuate and find direction. The noted prospect of Japanese (and possibly Swiss) intervention, however, could potentially help to limit the yen’s gains if it occurs. As for the US dollar, if Brexit affects the Fed’s prior monetary stance as much as might be expected, the greenback could also come under significant pressure going forward.

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