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FX Update : Markets set for an extended period of uncertainty, Britain faces the grim reality of negotiating a painful EU exit.

Written by Ian Dobbs on June 28th, 2016.      0 comments

Markets look set for an extended period of uncertainty and elevated volatility in the aftermath of the UK’s decision to depart the EU on Friday. Pain is being felt across the globe as investors have moved quickly to re-price those assets with the greatest exposure to a slowdown in global growth. Risk currencies such as the NZD and AUD have been in the crosshair, although the falls in them pale in comparison to the falls seen by the GBP which has fallen around 12% against the USD to lows last seen in 1985. The plunge is well grounded given that the path ahead for the UK is now highly uncertain. Estimates from the UK Treasury forecast are that the UK GDP could be anywhere between 5.4-9.5% lower in 15 years’ time should the UK proceed with a Brexit. Meanwhile the political landscape in the UK is disintegrating after PM Cameron resigned as he indicated he had no interest in being part of Britain’s EU exit negotiations which are likely to see the EU position to negotiate strongly to protect the integrity of the European project. Calls are mounting for a second UK EU referendum whilst a referendum on a Scottish exit from the UK in the not-too distant future is now a given.

Gains posted by the AUD/USD heading into Friday’s UK EU vote quickly evaporated during the afternoon as the vote count showed that Britain had chosen to depart the EU. It was an outcome that had been discounted heavily by the financial markets. The shock result led to severe volatility during the offshore session as the market tried to ascertain the implications that the unprecedented move would have on the global economy and the UK/European political landscape. Falls in the AUD/USD totalled almost 3.5c (~4.5%) at one stage as investors shunned risk in favour of safe haven currencies. Events last week in Australia were uneventful. The RBA minutes which having had come prior to the Brexit vote failed to indicate an intention to ease, although the subsequent uncertainty that will flow from the UK’s decision when combined with stubbornly low local inflation should lift the prospect for a cut in coming months. Data on house March quarter house prices eased slightly, although the private sector data suggests a renewed pick-up since the survey, particularly so in Sydney. Indicators this week include HIA new home sales on Wednesday and private sector credit data on Thursday, although expect attention to focus offshore and on the Australian Federal election at the weekend.

New Zealand
The shock decision by British voters who chose to abandon the EU on Friday saw the NZD plummet in trade during the afternoon. Highs above .7300 against the USD quickly turned into a fall of over 4% as the vote revealed an unassailable lead for the ‘leave’ campaign well prior to the last count. Risk currencies sold off heavily on the news after they had previously followed the GBP higher earlier in the day as the market chose to ignore polls that had warned of a tight race. The result saw the GBP fall ~12% at one stage against the USD to lows not seen since 1985. Prior to Friday’s UK vote saw the release of bottom tier local data which included the latest migration numbers which showed an easing in the net monthly gain. Credit card spending posted a smaller rise from the month prior whilst trade data for May released yesterday which beat expectations posted a modest rise from the month prior. Data releases this week feature on Thursday as the latest building consents and ANZ business confidence data comes to market. As with last week expect these to have no impact given the unprecedented event of the UK vote to leave the EU.

United States
Friday’s shock UK vote to leave the EU has left financial markets in turmoil after the decision and has seen investors flock to safe haven currencies like the USD in its aftermath. The move comes as investors ditch the pound (~-12%) and the risk currencies as concerns over UK/EU growth mount in lieu of the new highly uncertain global financial environment. The move has seen US equities drop sharply (S&P 500 -5.3%, Dow -4.8%) since Friday and has seen the market move to discount any prospect of a Fed rate hike in 2016/17. This comes as the market looks to price in the prospects of slower US growth and a smaller rebound in inflation. The UK’s decision comes at a poor time for the US as the domestic economy appears to be losing momentum amid a slowdown in employment growth and sustained contraction in business investment. Data from last week prior to the British vote had little consequence given the magnitude of Friday’s potential outcome. US existing home sales rose to 9 year highs, whilst the initial jobless claims employment indicator posted a larger than expected decline. New home sales were seen falling 6% in May, whilst durable goods orders for the same month disappointed after falling 2.2%. This week so far has seen the latest services  and Dallas PMI come in under expectations and the latest trade deficit show an expansion from the month prior. Other data to feature this week begins with Q1 GDP numbers today although expect Brexit sentiment to again feature predominantly.

United Kingdom
Friday’s shock decision by the UK in choosing to leave the EU has seen the pound crash to lows against the greenback not seen since 1985. The decline from Friday’s highs has so far  totalled around 12%, whilst Friday’s move of over 8% was almost double that of Black Wednesday in 1992 when the UK was forced out of Europe’s exchange rate mechanism. The decision which has sent shockwaves around the world has seen global equities plummet in its wake. Britain’s FTSE 100 fell around 8.7% at one stage during the day prior to moves by the BoE to add liquidity to the financial system. The decision now opens the door to a period of heightened uncertainty for the UK and Europe (and indeed globally) as British policymakers begin negotiations and look to eventually invoke Article 50 of the Lisbon treaty which will give the UK two years to negotiate an exit. The decision has invoked severe bickering amongst the UK political parties and has seen PM Cameron (who campaigned for the UK to remain in the EU) resign from his post. He indicated that he was not the right person to lead the UK forward in discussions in a move that has put the onus of negotiation on the Brexit campaigners (like potentially Boris Johnson) to navigate the uncertain waters ahead. Look for the GDP data on Thursday to be overlooked in light of the EU decision as investors look to the prospect of vastly reduced future UK growth and declining public finances should the UK proceed to leave the EU (note the UK politicians are not bound to actually follow the public’s vote).

The decision by the UK in choosing to leave the EU has seen the Euro decline sharply as investors weigh up what the move means for the EU. The process of negotiating a UK exit is likely to be long one as UK leaders look to cherry pick the best parts of the relationship and as EU leaders seek to protect the integrity of the European project by not yielding to wishes from Britain that may encourage other member states to go it alone. The prospect of reduced EU growth and an extended period of political and economic uncertainty has led to sharp declines across the European equity bourses. The Euro Stoxx 50 has fallen 11%, whilst peripheral markets such as Spain’s IBEX 35 which has fallen 14%, reflect elevated concern over outlying EU nations seeking their own independence. Expect volatility to remain high in the weeks and months ahead. The degree of volatility will depend on the response of the financial markets to central bank words and whether the vote is seen by European leaders as an urgent call to fix the EU’s current problems, or whether it alternatively leads to increased break-up momentum across the EU. Data prior to Friday’s referendum last week understandably had little influence on the markets. The German ZEW current conditions index beat expectations, whilst the latest euro-zone consumer confidence remained weak-  a condition that looks only likely to deteriorate further in the months ahead. PMI indicators were mixed and included disappointments in France and strength in German manufacturing.

The shock decision by the UK in voting to leave the EU on Friday has seen the Yen surge in trade after the news. The move was most notable against the ‘risk’ currencies and the British pound which has seen its exchange rate depreciate over 15% since Friday on the news as investors flocked to the relative safety of the Japanese Yen. The UK’s decision saw global equities plummet in the wake of the news. The near 8% decline in the Japanese Nikkei 225 on Friday was the largest decline in over 16 years and occurred as investors reacted to the higher Yen and deteriorating prospects for Japanese exporters. Japanese events last week had little influence on the market ahead of the UK EU vote. They included the latest BOJ minutes which showed policymaker concern over risks posed by overseas economies. Friday’s Brexit risk was seen as one of the key reasons that the BOJ didn’t move to ease further at the most recent monetary policy meeting. Trade numbers released on Monday posted a small fall from the month prior, whilst the latest indicator on Japanese manufacturing showed further weakness as conditions remained mired in contraction territory. Data this week starts with numbers on retail sales on Wednesday, although fortunes for the Yen will be linked to international markets and the prospect of BOJ intervention to stem its continued rise.

The volatility that has ensued after the UK voted to leave the EU on Friday has seen the Canadian dollar come under significant pressure on the news as investors moved to the relative safety of the USD. The decision which had been discounted by the market as unlikely, has led to a severe reaction across global equity bourses and has seen the price of oil marked lower by ~8%. This comes as investors fret over the potential for a decline in demand for oil if economic growth throughout the euro area falls sharply. Data from last week in Canada had little impact in light of the events going on globally. Wholesale sales were seen rebounding from the month prior, whilst April retail sales lifted in line with expectations at the headline level, although the core data was more than twice that expected. Data expected this week includes GDP for April and the latest index on raw materials pricing. Expect both to be quickly overlooked as the market looks past these historical reads in favour of the now clouded (post Brexit vote) outlook for global growth.

Economic Events (Tuesdays only)
  • Australian Q1 House Price Index, -0.2% q/q vs. 0.8% exp.
  • EU ZEW Survey-Economic Sentiment, 20.2 vs. 15.3 exp. (Jun.)
  • Canadian Retail Sales, 0.9% m/m on exp. (Apr.)
  • US Existing Homes Sales Change, 1.8% m/m vs. 1.1% exp. (May)
  • Japanese Nikkei Manufacturing PMI, 47.8 vs 48.2 exp (Jun.)
  • German Markit Manufacturing PMI, 54.4 vs. 51.9 exp. (Jun.)
  • US Initial Jobless Claims (Jun 17), 259k vs. 270k exp.
  • US Markit Manufacturing PMI, 51.4 vs. 50.8 exp. (Jun.)
  • German IFO-Business Climate, 108.7 vs. 107.5 exp. (Jun.)
  • US Durable Goods Orders, -2.2% vs. -0.5% exp. (May)