The financial markets and spectators across the globe are in a complete state of shock following the unexpected outcome to the EU referendum, where the UK has voted to leave the European Union.
Markets were completely reliant in the final lead up to the vote on following the bookmakers, who heavily favored a one-sided remain vote, and as such, were simply positioned for only a remain outcome.
Investors were guilty of ignoring the consistent opinion polls that repeatedly pointed out that the vote was going to be close and as a result, the possibility of a UK exit had been severely under-priced throughout the financial markets.
Make no mistake, around this time last year the markets were in complete pandemonium over what implications a “Grexit” could have on the global markets, and the ramifications of a “Brexit” will carry far more severe risks.
What happens next? ‘Sell the news’ is going to become the name of the game. Despite all of this historic movement in the British pound overnight, this eventual outcome has not been priced into the equity markets, and the open to both the European and US session later today is going to be under the watchful eye of the world. The GBP/USD itself dropped from a cliff overnight, and has recorded historic losses from 1.50 to 1.32 in a matter of hours.
It is important to point out that the reason for the GBP/USD falling to such extraordinary levels is not just limited to the UK voting to exit the European Union; investors have been very quick to also price in the uncertainty over the future of UK Prime Minister David Cameron and also the likelihood that this shocking news possibly opens the doors for another Scottish Referendum down the road.
There are also many other unanswered questions, such as whether this would this impact the UK’s credit rating and how the Bank of England (BoE) will react to such a shock.
There has also been an expected correlated move in the EUR/USD overnight, which itself has declined from 1.14 to just above 1.09 as a result of questions now lingering over the future of the European Union as a whole.
Headlines have circulated over the past hour alone around political parties in both Italy and France possibly planning on campaigning for their own referendums in the future. I would personally not see this as a major threat for the time-being, but it could be interesting to monitor the possible reaction in Denmark and Sweden following the news that the UK has voted to leave the European Union.
It must also be made clear that the unexpected shock overnight must have implications on the Federal Reserve and their intention towards raising US interest rates later in 2016. With so much uncertainty set to surround the global economy, US interest rate expectations must be pushed back, and Federal Reserve Chair Janet Yellen was very explicit in stating the risks a Brexit outcome could provide to the global economy.
This possible correlation has not quite yet been priced into the dollar, and if US futures point as sharply lower as what the European futures are currently suggesting, there is a threat of a knock-on effect on the dollar. We saw the USD plunge sharply lower following the events of Black Monday in August, and it is possible history could repeat itself if US markets enter trading under such heavy pressure.
Gold has reached its highest level since March 2014 as a result of safe-haven demand following the United Kingdom voting to leave the EU. After reaching levels beyond $1350 earlier in trading, gold is now consolidating somewhere around the $1320 region.
If risk aversion sweeps across the financial markets as expected following diminished risk appetite from investors, gold could continue to see further support due to its status as a safe-haven asset. Of course, this would be even more possible if US interest rate expectations do get pushed back as a result of such a shock overnight.
Due to limited attraction towards risk from investors, the oil markets have dropped as expected, because concerns over the global economy would naturally make investors question demand for the commodity.
What does this mean to the Bank of Japan? A UK exit outcome represents their worst nightmare. With risk aversion now likely to be a theme in the markets for a prolonged period following such a shock overnight, there is quite simply nothing the central bank can do to prevent yen demand from traders.
Can they intervene? Yes they can, but it would not be a wise idea to even consider this until this outcome has been priced in across the financial markets. If the BoJ are not patient in allowing investors to adjust to the outcome of the referendum and the possible ramifications, the BoJ simply risks entering a game of cat-and mouse.
In times of uncertainty, the Japanese yen becomes the best friend for traders, and despite all of the unbelievable gains for the yen throughout the first six months of 2016, the outcome to the overnight referendum has just encouragement towards the yen towards new levels.
Quite simply put, the reaction to gold, the Japanese yen, and how heavily equity markets are at threat of falling, is the simplest reflection of how unprepared traders were for this outcome.
Disclaimer: The content in this article comprises personal opinions and ideas and should not be construed as containing personal and/or other investment advice and/or an offer of and/or solicitation for any transactions in financial instruments and/or a guarantee and/or prediction of future performance. FXTM, its affiliates, agents, directors, officers or employees do not guarantee the accuracy, validity, timeliness or completeness of any information or data made available and assume no liability as to any loss arising from any investment based on the same.
Risk warning: There is a high level of risk involved with trading leveraged products such as forex and CFDs. You should not risk more than you can afford to lose, it is possible that you may lose more than your initial investment. You should not trade unless you fully understand the true extent of your exposure to the risk of loss. When trading, you must always take into consideration your level of experience. If the risks involved seem unclear to you, please seek independent financial advice.