Article / 28 June 2016 at 8:02 GMT

FX Update: The Brexit dead cat is bouncing

Head of FX Strategy / Saxo Bank
  • South Korea announces $17bn stimulus package, post-Brexit vote
  • Japan could follow suit with a much larger, 4% of GDP package
  • Rating agencies downgrade of UK a pointless exercise
  • EU response to Brexit vote just as important as London's position

By John J Hardy

South Korea announced a stimulus package overnight of approximately $17 billion, or more than 1% of GDP, while a Japanese newspaper reported that the ruling LDP’s chairman, Toshihiro Nikai is calling for a ¥20 trillion (more than $200 billion) stimulus package.

The latter is serious money – worth north of 4% of Japan’s GDP. This is why markets have bounced strongly overnight – the widespread belief is that fiscal stimulus is the inevitable next step.

But if we look at Europe and its budget rules and the US and the fact that the delay from here to the recognition of recession risks to actually announcing fiscal stimulus is extraordinarily long, we have to wonder what the prospects are for the stimulus meme to spread. 

The sticking point after the Brexit vote is the formal invocation of article 50 which starts the post-exit treaty renegotiation. Until then, there is enough noise about holding a second referendum to keep some modest sense of doubt in the air that the Brexit decision is final.

It appears that UK prime minister David Cameron is unwilling to take the step of invoking article 50, even as EU leaders are impatient for Britain to do so to get the ball rolling. Perhaps today’s summit will produce a development here — if not, we may risk a long wait until new UK leadership is in place before the formal process begins. The EU leadership’s general approach to the situation is equally as important as the UK’s during this phase.

The ratings agencies took the step of downgrading UK sovereign debt, a pointless exercise given collapsing yields after the Brexit and the fact that the UK can print its own money. Of course, one way of looking at sovereign debt these days is through the currency lens, as a weaker currency means debt is devaluing in foreign-currency terms.

EURUSD's direction

The volatility in EURUSD has been rather muted since the initial shock of the Brexit vote and we are somewhat surprised that the pair isn’t trading close to 1.0800 than 1.1100 at this point.

The zone of resistance is still uncomfortably large, i.e., the 1.1100-1.1200 area and arguably extends slightly above 1.12000, but we continue to look for a follow-up move lower toward 1.0800 from here on lingering existential concerns for Europe.

Tactically, the 1.1075/80 area has been providing resistance so far this week since Monday’s opening.

1.1075/80 seems to be the resistance to a shift lower
 Source: SaxoTraderGO

The G-10 rundown

- absorbing safe-haven flows and likely to weaken only if we see a notable general risk sentiment shift. The market is pricing in reasonable odds (20%+) of a Fed rate cut at the September FOMC meeting.

EUR – Looking lower on existential threat from the Brexit – 1.0800 first level of interest in EURUSD.

JPY – Buying dips on excess enthusiasm/dead cat bounce is one way to trade the yen, while danger of intervention if JPY strengthens.

GBP – Our assumption is that we have not reached bottom, but ad-hoc announcements could trigger brutal temporary rallies of several hundred pips, for example, in GBPUSD. Defensive leverage levels required.

CHF – A low beta JPY trade with even more active intervention threat.

AUD – a bit stubborn, but generally looking lower – technical interest picks up on next wave lower at 0.7275/0.7300 which has been a key zone recently.

CAD – Prefer lower, with USDCAD eyeing that 1.3190 resistance soon and 1.2900 the local support level.

NZD – As with AUDUSD, watching the key recent range lows toward 0.6960 as a trigger for further downside interest.

SEK - We remain clear of the recent range in EURSEK, but the bigger range to 9.60 has been in play since late 2014. Is there any notable potential catalyst?

NOK – the rally in EURNOK is not very convincing as the euro concerns battle risk-appetite concerns (normally NOK negative). Worst real rates among G10 NOK’s most critical fundamental problem.

Upcoming economic calendar highlights (all times GMT)
  • ECB’s Peter Praet to Speak (1100) 
  • US Apr. S&P/Case-Shiller Home Price Index (1300) 
  • US Jun. Consumer Confidence (1400) 


South Korea bangs a drum for a $17bn stimulus package to
deal with the post-Brexit vote fallout. Photo: iStock

— Edited by Martin O'Rourke

John J Hardy is head of forex strategy at Saxo Bank


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