Shock and awe in the currency markets after a surprise Brexit vote made that much more astonishing by the market clearly expecting the opposite outcome just ahead of the ballot.
Next week will be about picking up the pieces after this once-in-a-decade volatility, as the market gets down to considering the longer-term implications. Although there is likely still pressure on the JPY to strengthen if risk sentiment remains in a funk, we suspect that the Bank of Japan will be interested in defending the currency from further strength beyond perhaps 100 in USDJPY, so traders may prefer USD pairs for continuing to trade.
This is a straightforward trade – the market has been shocked lower, but there could be further downside ahead as the market considers the risks for the UK from the Brexit, given the country’s large external deficit of over 5% of GDP. Perhaps we’ve seen the bulk of the move lower in GBP in the near term, but traders may still look for opportune levels to get short as GBPUSD finds a new equilibrium at lower levels and perhaps tests marginal new lows toward 1.3000.
Trading stance: Bears will want the post-Brexit highs just below 1.4000 to remain untested and look for fresh dips to probe the lows below 1.3250 and even beyond to 1.3000 in the near term, trading with light positions in recognition of the extreme volatility potential – the post-Brexit intraday bounce, for example, was over 750 pips. Counterevidence: a rally north of 1.4000 that sticks suggests that the Brexit reaction was overdone, though a more complete reversal would actually require a swing above 1.4335 at minimum.
The CAD showed signs recently of underperforming during all of the market’s swinging back and forth relative to other risky currencies, and the story for the Loonie is not compelling from here, with oil off sharply on the Brexit vote and worries about the US economy also a worry for the heavily US-exposed Canadian economy. The recovery of 1.3000 in USDCAD was a technical sign that the focus is back on the upside from here.
Trading stance: USDCAD bulls will look for any consolidation to fall short of 1.2900 and focus higher on a break of the 1.3188 highs to lead to a push on the next resistance toward 1.3300+. Counterevidence: a close below 1.2850 would suggest a risk that the post-Brexit rally has been a red herring.
We’re likely facing a long extended bout of soul searching on the future direction of Europe, which could weigh on the euro against the major currencies, including a now more compelling safe haven US dollar, where interest in safe haven seeking from Brexit/EU existential risks and the risk of JPY intervention may enhance interest in the US dollar and overwhelm any USD negative sentiment from recent Fed dovishness. EU existential risks may serve as a long-term weight on the euro’s outlook from here, particularly against the US dollar.
Trading stance: EURUSD bears will look for the 1.1200 resistance to hold and then for a follow up move to 1.0900 and even 1.0800 in the week ahead. Counterfactual: a close above the 1.1200/50 zone would threaten to neutralize the bearish outlook and post-Brexit reaction.
Watching EURGBP with downside interest
It may be early enough to test the waters if judging that we saw an overenthusiastic reaction to the Brexit in terms of sterling weakness versus the euro – after all, the Brexit raises very serious long term questions for Europe and the future of its worst-off peripheral members as much as it raises questions for Britain.
Trading stance: Traders may look to take a reactive stance in EURGBP in the coming weeks in EURGBP, buying long dated put options structures (recall that volatilities still very high – so spreading strategies may be of interest) strategies for a return to the middle of the medium-term range in coming months if EURGBP rallies again, or looking to short the pair.
With Britain having said its piece, the focus will now switch to the euro
and to the health of the remaining 27 countries in the union. Photo: iStock
— Edited by Michael McKenna & Clare MacCarthy
John J Hardy is head of FX strategy at Saxo Bank