With just under two weeks until the Brexit vote, a poll by the Independent (UK) has signaled a potential massive shift in favor of a vote for the United Kingdom to leave the European Union on June 23. Before this most recent poll, public support for an exit vote was evenly mixed with many polls indicating a slight edge in favor of the UK remaining within the EU. This most recent revelation is certain to keep investors fleeing sterling (GBP), which has already been pummeled the last two weeks (see chart, click to zoom).
Rapid investor flight from sterling has been a recent pattern, most noticeably leading up to the Scottish succession referendum and during the first half of 2016 as Brexit talk began to take center stage. Given the already challenging economic outlook the UK faces, with declining industrial output and no sign that the Bank of England will raise rates anytime soon, global investors cannot be happy that the UK has seemed to lurch from one political integration crisis to the next over the past two years. Uncertainty has dampened demand for sterling (GBP) because investors wish to avoid excessive risk exposure. Safe haven assets, notably US Treasurys and francs (CHF), have continued to benefit from skittish capital faced with economic uncertainty.
The next 13 days are likely to see further weakening of sterling (GBP) as heated talk from Brit politicos such as Michael Gove and Boris Johnson and perhaps more polls similar to the latest from the Independent take center stage. This issue of the EU referendum is already front and center in the mind of most UK and commonwealth residents and the days leading up to the vote are certain to be chalk full of public deliberation. Given that the two most prominent political leaders of the leave and remain camps are Boris Johnson and David Cameron, respectively, neither side has yet to discover their cause's public rhetorical champion. As such, UK public opinion on a potential Brexit may still have many significant swings left before the vote.
For all the cross-talk, a Brexit is truly disadvantageous for the UK, European and global economies. Setting aside the clear harm of shrinking trade flow, small and medium sized UK businesses will face severe new challenges. Today, it is common for the the very smallest firms to be just as internationally-minded as the largest multinationals as they consider labor resources, suppliers and markets to sell in. Membership in the EU, as frustrating as it may be, has helped UK business thrive due to the predictable opportunity to access the world's largest trade bloc.
Those that doubt the substantial economic disadvantage prediction make two important replies. First being, a vote in favor of Brexit does not immediately modify the economic status quo, as it merely prompts the UK to begin the process of notifying EU members that it will be leaving the group. This notification will stand in place for nearly two years before any substantial economic ties are severed. Second, there is a widespread belief that the UK will be able to quickly negotiate a series of bilateral free trade agreements with the important and significant members of Europe in order to retain markets and resources access. However, as likely as it is that many European nations will share a mutual desire to maintain free trade terms, it is unlikely that suitable replacements to the EU free trade zone agreement will come as easily or as quickly as Brexit supporters seem to believe. The politics of trade agreements are difficult and unfortunately, the EU framework, as taken for granted as it is, has allowed European capitals to grow rusty in this area of diplomacy. Furthermore, it's too hard to predict what new pressures Europe will be facing two years from now to have much confidence that new trade liberalization agreements will quickly pop into reality.
Granting that Britain's Euro-skeptics are ultimately right that the UK will survive just as well without EU membership, the economic uncertainty and harm that will befall the UK during the transition and thereafter is still substantial and makes the looming potential Brexit too risky to be worthwhile. Beyond the UK, the potential harm to the rest of Europe is significant as well. A Brexit will cast further doubt on EU cohesion and may prompt swift consideration of exit by other members, including Inner Six nations France and Italy. Even if a Brexit does not initiate a domino effect that rends the EU, the loud rejection of integration it represents will only burden the European project further. As Europe reels from the migrant crisis and violent pressure from an economically flailing but militarily and politically assertive Russia, it's hard to see how any nations benefit from reversing integration.
- Sterling (GBP) gets pounded whenever Brexit talks dominate the news. The next 13 days will be volatile and sterling will likely fall further.
- As much punishment as sterling (GBP) has taken thus far, expect further declines if Brexit is voted into reality. The uncertainty that a Brexit generates will depress sterling demand. This rejection of sterling (GBP) could be deep and prolonged if UK negotiators don't achieve immediate initial-commitments about trade agreements.
- The most likely referendum outcome is to remain an EU member. Despite new polling data, the Brexit supporters are ultimately likely to fail. This is because integration is broadly supported by young people across Europe. Combine this with the feeling of UK racial minorities that Brexit supporters are an unwelcoming bunch and there is significant, politically active cohort that will vote against a Brexit.
- Rejection of a Brexit will result in a short term rally for sterling (GBP), if only because broad uncertainty about the UK's economic future will be put to rest.
- In terms of currency pairings, both the dollar (USD) and euro (EUR) have tracked sterling downward at similar rates, however, as the uncertainties of a Brexit grow to loom over Europe, the dollar is likely to come out strongest of the three. This means that selling cable (GBP/USD) will have greater returns than buying the euro pound (EUR/GBP) over the next two weeks.
Disclosure: No position.
Disclaimer: I hope this analysis helps you to be more informed and make money. The opinions in this document are for informational and educational purposes only and are not a recommendation to buy or sell any assets mentioned or to solicit transactions or clients. Do not act upon any investment information without consulting an investment adviser.