On 23rd June, the citizens of Britain will face a major decision that impacts the future of the country. With the European Union (EU) referendum just around the corner, a local opinion poll has shown that the ‘Leave’ and ‘Stay’ camp are currently in a deadlock, with 43% voting for the latter and 42% voting for the former and the remaining undecided. In response to the polls, the pound sterling market has reacted aggressively. Market participants are moving away from the pound to safe haven assets such as the yen, causing the pound to depreciate significantly over recent weeks.
What does it mean if Britain exits EU?
Should Brexit happen, its economic impact could be detrimental. With 50% of Britain’s export going to the EU region, brexit may signal the end of the free trade with EU, thereby resulting in adverse economic implications. In addition, an estimated 3 million jobs in Britain are reported to be reliant on the EU. An exit from the EU may put these jobs at risk, threatening the economic stability of Britain. With so much at stake, investors tend to be risk averse and would certainly refrain from investing in Britain until the situation becomes more stabilised. With short-term foreign investment and business sentiment set to be gloomy in the event of brexit, the demand for pound sterling will significantly decrease, eventually leading to a steep depreciation.
What is the situation in the pound sterling market now?
From the options market, the current implied volatility of the pound sterling market is at its highest in recent times. With the possibility of a Brexit looming, many players are currently trying to protect themselves against any sharp depreciation. According to HSBC, brexit could potentially cause a 20% depreciation in pound sterling by next year. It is therefore no surprise that demand for pound sterling pushed options to a record high with a significantly high premium being paid for them.
With the fear of brexit still fresh in the market, the pound sterling market is currently bearish as participants are pricing in the possibility of brexit. At the point of the referendum, traders and investors must be cautious of a spike in the pound sterling market. An exit will certainly drive the pound deep into depreciation. On the other hand, a decision to stay will cause the pound market to correct itself, which is likely to cause the currency to appreciate. With volatility set to be at record high this 23rd June, it would be wise to remember when the Swiss National Bank unpegged the swiss franc against the euro. Market participants who got caught on the wrong side of the trade will certainly face major losses.
Given that the pound sterling is one of the major currencies in the world, the brexit news will certainly affect markets beyond the pound. Given the high risks involved, it may be wise for us to stay out of the pound sterling market until after the brexit announcement. However, if you are holding any positions at the time of brexit, it’s best you hedge your positions in order to minimise your downside risk.