Are there trading opportunities after Brexit vote?

Last Friday (24 June) will go down in history as a momentous day for the markets as the United Kingdom (UK) voted to leave the European Union (EU). 

David Cameron
Source: Bloomberg

What made it so incredulous was the sense that many in the markets were expecting the status quo to prevail, right up to the start of the vote counting. You may say that the markets were complacent and positioning for ‘Remain’.

Now that the referendum is done, what’s next for traders? It must be stressed that the UK is not technically out of the EU yet. Until Article 50 of the Lisbon Treaty is invoked, whatever discussion is more political than economic. The UK still needs to sort out the mess, with PM Cameron to resign in October. Major credit agencies cut the credit ratings of UK over worries of a less predictable and stable policy framework.

Needless to say, there is a great deal of uncertainty in the markets. This means global capital flows until then will be based on expectations of what is the path ahead. Investors will be making decisions on what they anticipate, instead of on what has happened.

In addition, as we head into the summer months, the traditional period of low liquidity and high volatility will likely amplify movements in the markets. The implications of the Brexit outcome will lead to less risk taking. Sidelines appeared to be an attractive place to be at.


Sterling pound looks vulnerable

But the post-Brexit reality magnifies certain trends, which is worth a look. A key risk is the possible removal of the sterling pound as a reserve currency, given the uncertain prospects for the UK economy.

Even if this does not develop, it is not illogical for the GBP to fall further. Growth in the UK is feeble, and talks that the Bank of England (BoE) could add a fresh round of asset purchases certainly did the pound no favour. However, the BoE said in a post on its website that they cannot (and should not) stand in the way of necessary adjustments in financial markets, suggesting that it will take a lot more damage before the central bank will act.


Will the central banks respond?

At the moment, central banks seemed to be in a contemplative mood. The reason for this is that it is still not clear whether the Brexit vote represents a temporary shock to the financial markets or something more permanent. Deciding which is which is critical, as the prescribed solution depends entirely on this assessment. If it is perceived to be the latter, the clear response is likely to be a coordinated central bank action, where the first order of business is to ensure liquidity is ample through swap lines and easing policies.


Will USD and JPY march higher?

The US dollar gained the most since 2008 on 24 June after the Brexit vote. If the greenback continues to strengthen despite lower prospects of US rate hike, we could see a risk to emerging economies holding significant USD liabilities. A redux of the concerns in early this year, if you will.

On the charts, we might be seeing the formation of a triple bottom in the US dollar index. If so, we could see a more aggressive move higher in the USD in the coming sessions. However, we need to be aware that the Fed is not overly fond of a strong USD because it disrupts their goal of higher inflation.

The Japanese yen remains strong, as risk aversion favours safe haven demand and narrowing yield spreads. While the consensus is for the Bank of Japan to announce additional easing at the 29 July meeting, the JPY uptrend may remain relatively intact as long as risk appetite stays muted. However, what may hold back further yen strength is the fear of unilateral intervention in the FX markets in the near term. In the longer term, more fiscal support and a QQE expansion should restrain the yen.


Banks and energy eye Brexit fallout

We already seen how the Brexit vote roiled the banking sector and energy prices. HSBC and Standard Chartered continued to head south, chalking up around 10% of losses between 24 and 28 June. The MSCI Singapore Financials index fell 2.3% on Brexit day. Likewise, the S&P 500 Financials Sector fell a combined 8% in two straight sessions. Oil prices retreated further from $50. Further declines would put considerable strain on oil companies, some who were counting on the oil rally to restart or increase production.

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