John J Hardy
The UK’s exit from the European Union is causing volatility in GBP, says Saxo Bank’s head of FX strategy John Hardy, and may be the start of a squeeze on sterling pairs.
Article / 14 June 2016 at 12:30 GMT

Risk-off, Brexit on?

Head of Trading / The ECU Group plc
United Kingdom
  • German 10-year bund yield slides into negative in "absurd" shift
  • Brexit is not responsible for everything but assets are being revalued
  • The Sun headline-call for Brexit ups the ante for the June 23 referendum
  • Euro could face backlash once dust settles after referendum


Danish homebuyers can now borrow money for 30 years at cheaper levels
than the US government but can we blame this one on Brexit? Photo: iStock

By Neil Staines

“What you risk reveals what you value” — Jeanette Winterson

This morning,  the 10 year German Bund yield fell below 0.00% for the first time. The concept of lending the German government money for 10 years…for nothing, was until recently an absurd concept - particularly when we consider the wide debate during the global financial crisis fallout (ironically largely by the Germans) about what should constitute the risk-free rate, the cornerstone for global credit markets. A negative risk-free rate makes little conceptual sense.

Against the current, nervous backdrop, it appears that every headline describes market moves as being a function of Brexit-induced risk aversion. The fact that Danish homebuyers can now borrow money for 30 years at cheaper levels than the US government surely hints at wider global economic imbalances than simply the threat of the UK leaving the EU.

However, perhaps the increased focus on the possibility of Brexit has led to the beginnings of a revaluation of assets. We have long been advocates of a lower equity market, and while the focus has shifted towards the UK, global equity markets are quietly faltering - a continuation of this decline remains our strongest conviction.  

“There can be no democratic choice against the European treaties” —  Jean-Claude Juncker

The Sun became the first national newspaper (Britain’s biggest by circulation) to come out in favour of ‘Leave’ and in doing so highlight an important British character trait. From a psychological perspective, patronising or arrogant threats are likely to have the opposite of desired effect. “The Remain campaign, made up of the corporate establishment, arrogant Europhiles and foreign banks, have set out to terrify us all about life outside of the EU.” [The Sun]

From an economic standpoint, Cass Business School professor David Blake published his own analysis of the Treasury (long- and short-term) models that predicted GDP per household would be £4,300 lower by 2030 in the case of Brexit.

Blake highlights a number of inconsistencies in the longer term model including the fact that UK’s share of exports to the EU fell from 54% to 44% between 2006 and 2015, while the single market was deepening. His analysis suggests that the same model would also predict that the UK would be better off joining the euro and that if Scotland left the UK its trade with the rest of the UK would fall by 80%.

"There’s the risk you can not afford to take; there is the risk you can not afford not to take”  — Peter Drucker

When it comes to the short-term model, Blake’s analysis highlights that it is the underlying assumptions that dominate the Treasury’s results. Their assumptions are that the economic shock would be equivalent to 50% of the shock of the global financial crisis, and that this would remain constant throughout the 2-year period after Brexit, cutting UK trade with the EU by 50%.

Yet we will still be in the single market during this period. The Treasury model also assumes that there would be no policy response. Blake concludes: “In short, the Treasury’s reports are completely unbalanced because they consider only the benefits of staying and the risks of leaving - but not the benefits of leaving and the risks of remaining.”

“The greatest enemy of knowledge is not ignorance, it is the illusion of knowledge”  — Stephen Hawking

As this week progresses, it is likely that volatility continues to increase (VIX - or the volatility index for the S&P 500 index - has risen sharply over the past 24 hours to its highest since the equity market turmoil of February). Federal Open Market Committee, Bank of England and Bank of Japan meetings are likely sideshows, with all expected to hold fire.

The result of the UK referendum on June 23 has profound binary implications for policy in the UK and US and significant implications for monetary policy in the rest of the globe. It is likely that statements this week will try to walk as neutral a line as possible.


The BoE will likely try to walk a neutral line this week. Photo: iStock

In FX markets, GBP is likely to become increasingly volatile, and while the risks of a Brexit have clearly risen, participants should not underestimate the weight of short GBP positioning and hedging that has been put in place, and the implications for GBP should that need to be unwound (next Friday or indeed before).

Whatever, the result of the UK referendum, we would expect the EUR to come under increasing pressure once the dust settles. Following a cyclical bounce, Eurozone growth looks set to turn down across the region, and with monetary policy at (or past) the point of diminished returns, and with anti-EU sentiment on the rise, EUR is likely to become increasingly vulnerable.

— Edited by Martin O'Rourke

Neil Staines is head of trading at The ECU Group


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