The UK referendum on its membership of the European Union is one of, if not the, biggest risk event for the financial markets this year and with only a week to go until the vote, it is impossible to say with any degree of confidence which way it’s going to.
The polls have been very volatile in recent months, with the Remain campaign at times taking a convincing lead only for the Leave campaign to claw their way back into it. As we enter the business end of the campaign, the polls suggest the Leave camp has edged into the lead and with momentum on their side, a Brexit has suddenly become a very real possibility.
Of course, as was the case with last year’s election and the Scottish referendum, some polls and studies tend to give a better idea of the final result than others. The online polls were the least reliable on these occasions, whereas phone polls provided a more accurate reflection and betting odds gave the best foresight, for example predicting an overall majority for the Conservatives.
The betting odds have suggested that the voting is in fact not close and it’s these that the markets have appeared to be paying most attention to. Even last week, the implied probability of the UK remaining within the EU was around 80%. This has since slipped to around 60% and if the current momentum is maintained, the Remain campaign could find themselves behind by the weekend.
The decline in the implied probability of a Brexit has been accompanied by some heavy selling in the pound and general risk aversion throughout the markets, with European equity markets in particular coming under pressure.
The FTSE is already some way off the highs it traded at last year and yet, prior to the last week or so, there was a feeling that traders were potentially ignoring the Brexit risks. That no longer appears to be the case and while it could be argued that a Brexit would benefit the FTSE long-term – majority of companies in the FTSE 100 are multi-nationals that earn the majority of their profits abroad – the short-term shock could put significant pressure on it, as well as other risk assets.
The break below 6,000 today has been seen as a significant move which signals the growing nervousness around the referendum. In the event of a vote to leave, a move back towards this year’s lows – which came in the midst of the panic over China at the start of the year – would not come as much of a surprise. In times of uncertainty – and this certainly qualifies as such – markets can become very risk averse and during these periods, equities can often suffer.
The pound has fallen from 1.47 to 1.41 against the greenback in the last week alone, before catching a bid around what has become a fairly reliable support zone over the last few months. While this has provided temporary relief, I think we could see further significant losses if the Leave campaign continues to sway voters as it clearly has over the last week. This year’s low of 1.3835 could offer further support for the pair but if momentum remains with the Leave campaign, we could see it trading at the lowest levels since the 2008 financial crisis.
The pound has also run into some difficulty against the euro over the last week but the moves here have probably been less significant than against other currencies. The simple reason for this is that a UK divorce from the EU would not just be painful for the former, in fact, given the fragility of the euro area, the latter could also suffer considerably in the event of a Brexit.
The pair has still rallied though, potentially suggesting that markets still believe the UK would be worse off, or perhaps a complacency when it comes to the negative implications for the eurozone. Regardless, the pair has run into temporary resistance around 0.80 and for a second day, this level has been rejected and fallen back towards 0.79. Should we see further weakness in the pound, this year’s highs around 0.8117 could come under pressure quite quickly, followed shortly after by 0.8150–0.8180. In the event of a Brexit next Thursday, the upside could be quite severe and the shock element alone could send the pair sharply higher. A move towards 2013 highs may not even be off the cards
The Brexit exposed pound has been pummelled by the risk-averse yen over the last couple of weeks, down almost 10%, and with it already trading at near three year lows, further losses could still be in store. The pair may have found some support over the last couple of days but unless the Leave campaign stalls, which of course it could, I suspect Brexit fears could drive the pair even lower as we near the referendum. The pair could find support around 1.47–1.4775 in the short term, but in the event of a risk, I wouldn’t be surprised to see it trading back towards 1.40, or even lower, as traders look to dump the pound and seek out the safety of the yen.
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