The EU Referendum takes place in the UK this coming Thursday, on June 23rd. This blog post is not intended to point the pros and cons of either vote, but instead a quick & simple explanation of how the Brexit event is and will impact the financial markets in the UK and globally.
A word on Brexit and the financial market generally
On the whole, the financial market participants would prefer for the Remain Camp to win the EU Referendum this coming Thursday. I am writing that on the basis of how the market responds to information leaning towards either camp.
Generally speaking, when there is information that supports the Leave Camp, the British Pound (GBP) weakens, and the global stockmarkets take a dive. When there is information supporting the Remain Camp, the opposite happens.
A win for the Leave Camp will likely significantly weaken the British currency and the British stock market (broadly represented by the FTSE100 index). Additionally it will also create a lot of uncertainty for the financial markets globally, whether that be in Europe or the US. In this respect, it doesn’t matter where Leave or Remain is better for the UK people or the UK economy in the short and/or long run. The market thinks it will be bad – so if Leave wins, then the market sells off.
“Risk-on” and “Risk-off” instruments
One method for categorizing financial instruments is to divide them into “Risk-on” and “Risk-off”. Basically when things are going well (whether on a short-term, medium-term or long-term time horizon), market participants like to take on more risk – thus they buy equities, commodities, any currencies driven by these i.e. the Canadian dollar, the New Zealand dollar, and the Australian dollar. When things are not going well, they look for safe-haven (or “risk-off”) assets such as the Swiss Franc, the Japanese Yen, and they buy commodities such as Gold and Silver.
Risk-on instruments will be strengthened by anything that indicates that the Remain Camp will win. Risk-off instruments will be strengthened (and risk-on instruments will weaken) by any information indicating that the Leave Camp will win.
Good reading: BBC article on “risk-off” investments
An illustration of this principle in today’s trading session
At 1:30pm, another Brexit poll was released. The poll favoured the Remain camp by one percentage point. As this was tighter than expected the poll results had a significant impact. The polls over the weekend had shown the Remain Camp quite well ahead, and for this reason the equity indices and the British currency rallied strongly on Monday and Tuesday. With this poll, market participants had (probably) expected the result to be well in favor of the Remain Camp, rather than just being ahead by a single percentage point. Hence the market reacted negatively to the data.
Any instrument regarded as “risk-on”, e.g. equities, oil, oil-dependent currencies (AUD, CAD, NZD) turned negative. And naturally, GBP also became quite weak. As my overall position was effectively long (bought) risk in the form of NZD, AUD(x2) and the DAX, and was long GBPCAD and GBPCHF, the £500 paper profit was quickly eroded and my account now showed a small negative number.
The markets got pretty choppy after that and there were to be scheduled comments from ECB’s Draghi (at 2pm) and Fed’s Yellen (at 3pm) – so I decided to stay out for the rest of the session.
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