When looking at the possible repercussions of each decision it is worthwhile noting two things. Firstly, we have seen a substantial amount of ground lost recently which would likely be made up relatively swiftly should we go back to business as usual next Friday.
However, on the flip side, we have already seen a great degree of selling prior to this vote as risks are increasingly baked into price. However, when looking at the current account differentials between the UK and other major economies, it is clear that perhaps there is an argument for sterling to be weak. Standing at over five times GDP, the UK has the worst current account deficit of any developed nation.
This highlights that perhaps the pound’s valuation is also reliant upon the inflows and outflows from the economy and not simply sentiment surrounding a potential Brexit.
The chart below shows that typically there is a lag of two-three years between a current account peak and the value of sterling against the euro and dollar. With this in mind, it makes sense to look for longs against currencies from an economy with a large (and growing) current account deficit, or shorts against those with a large (and growing) surplus.
The dollar is one major economy running a decent sized deficit, whereas Japan has a large surplus.
For a potential long situation in the event of a ‘remain’ vote, we have chosen GBP, given the fact that the US, like the UK suffers a relatively sizeable trade deficit. The long-term picture of GBP/USD clearly shows that the pair is hugely cheap by historical standards, with the $1.35-$1.42 zone generally only reached fleetingly over the past 30 years.
Clearly, the shift towards a greater chance of a Brexit in recent weeks has driven a sharp move back into this zone. However, many will see this as a strong long-term buying opportunity should they believe the UK is likely to remain in the EU. There is a good chance that the only way we break to a new 31-year low (below $1.3504) would be in the event of a Brexit.
Given the significant risk associated with a Brexit, it is likely that the selling we have seen over the past year will have increasingly factored in this risk. Thus should we see a ‘remain’ vote, there is good reason to believe that GBP/USD will begin a recovery phase, with $1.600 a likely target over the long-term.
Of course, this is dependent upon the UK remaining in the EU, where a Brexit would likely carry a significantly sharper and more prolonged sell-off rather than a gradual move.
The lack of major support levels below $1.35 means that targets would be hard to come by, yet a move down towards $1.25-$1.27 levels arguably seems possible.
Arguably, the most at risk currency pair in the event of a Brexit would be GBP/JPY. The expectations of substantial GBP weakness would be coupled with yen haven flows and overall GBP/JPY weakness owing to current account differentials. Given the gains we have seen in the yen over recent weeks, coupled with the substantial losses in sterling in recent months, we could see some sizeable and long lasting moves off the back of next week’s result.
The monthly chart highlights the fact that sterling has already seen significant outflows in anticipation of a possible Brexit, with the pair at a 32-month low. However, in the eventuality of a Brexit, there is reason to believe we could see a substantial move lower, where ¥140.00 and ¥116.84 represents the most significant support levels.
However, given the depreciation we have seen of late, there is reason to believe we could see a strong bounce should the current worries prove unfounded. In which case the most obvious levels to watch are ¥163.00 and ¥195.90.