Pound rallies on renewed support for 'remain' vote, US Dollar shrugs off dovish Fed
20/Jun/2016 • Currency Updates•
Financial markets continue to respond primarily to the latest news on Britain’s EU referendum.
The shooting of Labour MP and prominent ‘remain’ campaigner Jo Cox by a man with far-right ties brought a stop to campaigning on both sides last week. The expectation that this tragic event may hurt the chances of the ‘leave’ campaign buoyed the Pound and, to a lesser extent, the Euro.
The US Dollar performance last week was impressive, mostly holding its own in spite of dovishness from the FOMC. The Federal Reserve maintained its expectations for two hikes this year, which is in line with our own. However, expectations for long term rates were brought down significantly.
This week’s EU referendum represents the key event risk of 2016. The binary nature of the outcome guarantees sharp moves in financial markets and most of all in Sterling.
We still expect a ‘remain’ outcome, albeit by a thin margin. Statistical analysis and bookmakers agree that, despite the late ‘leave’ surge in the polls, the likelihood of a Brexit result is around 35%.
Join our twitter chat on June 22 at 3pm. We’ll be discussing what to expect from Sterling on referendum day.
Major currencies in detail:
As the referendum nears, all other issues have disappeared from Sterling’s radar.
Further polls showing ‘leave’ ahead hammered Sterling on Thursday, bringing it dangerously close to 1.40.
Then, the tragic news of MP Jo Cox death resulted in a sharp short covering rally that brought Cable near 1.44 by Friday close. Markets are expecting this terrible event to hurt the ‘leave’ campaign and early poll evidence over the weekend suggests that this may indeed be the case.
These FX moves are but a taste of the volatility we expect to see this week. In the event of a Brexit, our expectations are for an immediate drop in Sterling of around 10% against the US Dollar and a 5% rally if ‘remain’ wins, with Sterling moves against the Euro of -8% and 4% respectively.
Trading in EUR/USD last week was mostly a sideshow as all attention is focused on the UK’s EU referendum. The currency cross tracked the GBP/USD rate, although with a dampened amplitude of movement.
Under normal circumstances, the publication of the critical Eurozone PMI business sentiment indicators this week would be a key event for the Euro. However, we expect this data to be completely eclipsed by the latest polls and news from the EU referendum in Britain.
A vote to ‘leave’ would almost certainly bring the Euro sharply down against the US Dollar, whereas a ‘remain’ result would probably provide a short term boost of a smaller magnitude.
To add to the asymmetry of the situation, a ‘leave’ result would force most strategists, ourselves included, to revise quite a few of our base assumptions of the European economy and downside risks over the medium term.
The Federal Reserve’s June meeting last week proved to be somewhat anticlimactic.
Interest rates were left unchanged, as expected, and the main news came from the Fed expectations for their future path. The median figure now expects the Federal target rate to end 2018 at just 2.4%, down from 3%, and the long term steady state level is expected to be just 3%, down from 3.3%.
However, the US Dollar took some comfort from the cautiously optimistic tone of Fed Chair Janet Yellen and her suggestion that a July hike is still a possibility. Hence, the US Dollar did not suffer much. In fact, given the sharp downward revisions to the FOMC’s expectations for long term interest rates, the US Dollar’s performance, ending just marginally down for the week in trade weighted terms, was rather impressive.
Aside from Yellen’s testimony on Tuesday, there is little in the US economic calendar to distract from the EU referendum in Britain and we expect the US Dollar to trade largely in reaction to polls and electoral results from the UK.
Receive these market updates via email