Due to the uncertainty associated with the recent political events and current government action, the BPI has responded to any negative developments by slashing its Brexit commentaries. “Brexit” in the BPI’s parlance means “British exit from the European Union”. In its wake, we are seeing a major market correction that is taking the pound down at an alarming rate.
The extent of the correction can be gauged by the fact that it has become the focal point of currency markets. More particularly, the Japanese Yen is seeing a very sharp appreciation and is now the fifth most valuable currency pair against the USD. Furthermore, the Canadian dollar is also seeing its share value rise as more investors are seeking to protect their capital from the downward-moving British Pound.
This upward trending of the Canadian dollar along with the Japanese Yen makes investors much more concerned about the implications of the upcoming UK fiscal stimulus package. What is the likelihood of a large-scale weakening of the GBP as a result of fiscal stimulus? Here is my view:
The forex traders are not ignoring the risk. Indeed, this is an obvious risk and one that the Forex industry takes very seriously. One must never underestimate the power of macroeconomic trends such as economic trends which have great implications for the major economies across the globe. Let us see how this plays out with the recent political events.
You may recall that the Soviet Union broke up. We all know that the political and economic climate has undergone a very significant turn and the very long-term implications for the political and financial stability of the United Kingdom could be profound.
At present, the Forex market is extremely exposed to monetary policies of the US Federal Reserve. When one considers that the US is on the verge of a recession, coupled with its slowing growth, we have a perfect storm on our hands. Moreover, many believe that the recent incident between the United States and the British government will affect the economy of the US at the end of the day.
To prevent the damage caused by the political drama, Peter Todd, founder of LPL Financial and one of the prominent experts on currency markets, has issued a forecast stating that the currency markets would react negatively to Brexit. Here is why he thinks so. Let us take a closer look at his argument.
Peter Todd first points out that the UK government has promised to leave the European Union and thus has signalled the exit of the UK from the European single market. Furthermore, he believes that there are significant risks associated with leaving the single market. This will in turn negatively impact on the trade between the UK and EU.
His second point of concern is related to the state of the GBP/USD curve and is based on the correlation between the GBP/USD and the Japanese Yen. Here is his reasoning:
His argument revolves around the fact that in the last year the Yen has appreciated significantly against the US Dollar and consequently, that has resulted in the trend of speculative pricing being driven by the availability of a particular trend. If the trend is reversed, one will be forced to accept much higher yields than were available before the reversal.
There are other risks involved in the trade associated with the British Pound. However, I am confident that the UK will make a new government. Further, it should be noted that Peter Todd has been consistently wrong and has failed to see the correct markets when he was predicting the US-China trade as far back as 1992.