Today's edition of the Saxo Morning Call features the SaxoStrats team discussing the continuing weakness of the US dollar as commodity prices recover ground and in the wake of key US equity indices hitting all-time highs Thursday.
Article / 20 June 2016 at 14:32 GMT

Saxo on Brexit: Markets aren't worried – why not?

Blogger / MoreLiver's Daily
  • Financial asset prices suggest small risk premiums for Brexit 
  • If markets are right, the risks are grossly exaggerated by "Remainers"
  • Short-term bets on negative Brexit could be hurt even if "Leave" wins.

Fear abounds but there really is no reason to panic. Photo: iStock

By Juanhi Huopainen

When big macro events are all over the headlines, remaining composed is difficult. Due to the very political nature of the European Union, everyone seems to have an opinion on the matter, and not only in Britain, but all over the world. This can lead to the event being blown out of proportion as the economic, financial and political impacts are grossly exaggerated.

It is therefore a good idea to look at how financial asset prices have really reacted, and try to find alternative explanations for those price changes. After other explanations are covered, the residual effect should be something that could reasonably be blamed on the Brexit.

A close race at the finishing line

Polls were suggesting a win for the Remain side until a few months ago, but not by a huge margin. Durin the past few months the opinion polls have shown the support for Leave increasing, which turned the race slightly in favour of Leave.

Then the murder of Jo Cox, the pause in campaigning and reports of negative economic effects turned the poll back to evenly split during the past weekend. The share of undecideds remains high and their eventual decision remains unknown. Even voting intentions are unclear. The race remains close.

Betting markets reliable?

The betting markets show Remain winning with a high probability. My gut feeling is that the betting markets are not reflecting the situation accurately. I think many who bet on the outcome are too optimistic about a win for Remain. The punters are a biased sample and are pushing the odds with their bets.

The betting agencies are not making the probabilities, but are just balancing their books. The current implied probabilities of 20% Leave, 80% Remain are not close to the true probabilities, but they cannot be arbitraged away.

Not quite European, but neither is it USA

As far back as I remember, investors have viewed Britain as being somewhere in the middle of USA and the rest of the Europe – and not only geographically. The GBP tends to sail together with the USD and the EUR. If the EUR is considerably strong, it usually is strong against the GBP as well. If USD is very weak, the GBP usually tends to be weak against the EUR. This dislocation is even clearer after the euro crisis. Because Britain is not a member of the European Monetary Union, it was able to turn around its economy quickly after the crisis.

10-year bond yields

Britain’s ten-year government bond yields are closer to the yields of the US than France or Germany.  Even with the race close, the yield have not dramatically increased (questioning of solvency) or decreased (recession ahead) when compared to the US yield. My conclusion: no panic evident

10y yields
 Chart source: Saxo Bank

2-year bond yields

The movement of the two-year yields tell more about the changes in central bank policy than the longer-term outlook of the economy. The Federal Reserve hiked rates in December 2015, and the hike was expected long before the event.

Earlier in 2015 it was expected that the Bank of England would follow the Fed’s example and also raise rates.  As the inflation outlook deteriorated and the Brexit-referendum was approaching, rate hike expectations died. But the difference between the US and UK is not huge – it basically shows the Fed ahead by the one hike already done and half-a-hike to be done during the next two years.
 2y yields
Chart souce: Saxo Bank

2-year yield spread and foreign exchange rates

The two-year rate spread between UK and US is strongly correlated with the GBPUSD-exchange rate. When the rate spread favours UK, the GBP tends to appreciate, and when it favours the US, the USD tends to appreciate. To my eye, the recent weakening of the GBP can be fully explained by the interest rate differential.

2y spread fx
 Chart source: Saxo Bank

Stock markets

This is a bit tricky. The UK stock market has underperformed both the German and the US stock market when the index developments are calculated in USD. But most of the underperformance is explainable by the weaker GBP. If one assumes that the GBP weakening is tolerable, the effect of the Brexit threat is small. True, markets have tanked worldwide after mid-June, but I suppose if Brexit were the main cause of that, wouldn’t the effect have hit the UK harder?

 Chart source: Saxo Trader

Saxo Trader
 Chart source: Saxo Trader

Conclusion: “Leave” or “Brexit” are not disasters
If the probability of Leave winning is notable, and the economic effects would be so clearly bad, why aren’t investors discounting it?


1) The market knows that Leave will not win, or Leave would not result in a Brexit (unlikely that investors would collectively hold such information but no-one else hasn’t).


2) The effects of Brexit are grossly exaggerated for political reasons – investors don’t think a Brexit would have large negative effects.


3) Investors are stupid and wrong, and simply cannot price in an event that the media, think tanks, politicians and economists have been talking 24/7 for months.

My money is on the option number two. I don’t doubt that Brexit would have some negative effects, but the talk about another Lehman-moment or financial stability being at risk is scaremongering.

There are plenty of people who have shorted stocks, bought puts and sold the GBP short. As insurance, just in case, or with a quick profit in their mind. In the case of “Leave” winning, they will likely get a knee-jerk reaction from the market in their favour, but that reaction might not last for long. If “Remain” wins, they will be burned badly. In either case, those punters will have to run for exits after the referendum. I wouldn’t be much surprised if the GBP and stock markets would rally even if “Leave” wins.

– Edited by Clare MacCarthy


Juhani Huopainen is a blogger and a macro analyst at MoreLiver’s Daily

zefy zefy
Excellent summary of different scenarios!
Neil D Neil D
I think your synopsis is very well argued Juhani...........I'm with you on the last point, my spare cash will be put to work if the stock market manages to somehow see a 10% drop! So much hot air and hype being spouted but the vote IMHO will be close!


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