The UK officially decided to leave the European Union on June 23, with leave votes trumping remain by 51.9% to 48.1%. A total of 33.5 million voted. Mayhem ensued in the markets, with the British pound dropping more than 10% to a 30-year low of 1.32 against the US dollar and the Japanese yen strengthening 6.6% past 100 during the day.
Gold rose to US$1,315 per ounce, while Brent crude dropped to US$48 a barrel, weighing on commodity currencies like the Canadian dollar, Australian dollar and Malaysian ringgit. Finally, UK Prime Minister David Cameron stunned markets with his resignation, saying that the UK now required “fresh leadership” as it steers a new course.
“Brexit came as a surprise as the market had turned up on expectations that the UK would remain in the EU following the murder of Jo Cox. The betting polls also suggested the remain camp had a strong lead over leave. This explains the strong reaction from the market today,” says Sue Ann Lee, UOB economist. Over the short term, she expects US Treasuries and gold to continue rallying, while global equities will weaken.
What next? In the weeks ahead, Lee says she will be watching out for a rate cut to 0% by the Bank of England to alleviate the upcoming stress to the UK economy as businesses reconsider their expansion plans in the months to come. Ratings agency S&P has already warned that the UK will lose its AAA credit rating, which is now “untenable under the circumstances”.
GBP, EUR to fall
Heng Koon How, senior investment strategist at Credit Suisse, warns that the GBP may fall further as a result of the UK’s current account deficit, which is the second largest in the world at 7% of GDP, and if the economy goes into recession. “The GBP will go lower, so we would advise staying out of this trade until things have settled,” he says. Heng sees the GBPUSD falling towards 1.32 and the GBPSGD heading towards 1.85 in the months ahead.
Andy Seaman, chief investment officer at Stratton Street Capital is even more bearish. He warns that the GBP could reach parity with the USD as the economy slows and businesses avoid the UK. “It will take years for the UK to renegotiate trade deals with its partners and in that time the GBP will likely continue sliding and even eliminate the need for a BOE rate cut as the currency weakens on its own,” he says.
The euro is also expected to weaken. One reason is continued easing by the European Central Bank, which recently began its investment-grade corporate bond purchasing program to boost growth. “The EUR will fall in the short term in view of the uncertainty but rise in longer term owing to the strong current account surpluses of economies like Germany and Holland,” says Seaman.
Saxo global macro strategist Kay Van-Petersen disagrees though. “We would go short on the EUR over the long term,” he says. “We think that the market has underestimated the extent of the damage and uncertainty to the EU now that Brexit has happened and has yet to price in the inherent weakness of the currency.”
Flight to safety
Meanwhile, the US Federal Reserve will also be more cautious in raising rates as uncertainty casts a pall over the global economy once more. However, Lee still expects the central bank to raise rates at least once this year on improving US economic data.
The weakness in the GBP and EUR will also support the strength of the USD. Van-Petersen is already advising clients to take long positions on the USD, while Heng is predicting further USD strength against Asian currencies such as the Chinese renminbi and Singapore dollar. He expects the USDSGD to head towards 1.38 by year end.
More easing from the Bank of Japan, which has yet to intervene to taper the strength of its currency, could also be on the cards. For now though, Heng and Van-Petersen see continued appreciation of the yen as a safe haven play. Heng sees the USDJPY head towards 92, while Van-Petersen is also recommending long positions on the currency. “Until the dust settles and things start to stabilise, we would stay with the USD, yen and the Swiss franc,” he says.
This article first appeared in The Edge Singapore Market Report.