There’s no doubt the event of last week will be the event of the year as stunningly the United Kingdom decided to leave the European Union after forty three years being part of the common block. The vote was a very close call, with tension reaching surreal dimensions on the night following the referendum, and market reaction was tremendous.
GBPUSD collapsed from around 1.50 to below 1.35 in a matter of few hours and virtually all the US dollar pairs have made the same move as market participants took shelter in the safe-heaven status of the US dollar.
JPY was also bought aggressively as the USDJPY traded below the one hundred mark and EURJPY collapsed below the 110 level in a virtually vertical move. Equities all over the world tumbled as uncertainty reigns and central banks coordinated actions in order to calm markets.
As a magnitude, the event can be compared with the 2008 financial crisis and if we are to keep similarities, it means that in order to solve this UK situation markets need some time to cope with the new normal.
Following the referendum’s outcome, UK’s political class is in turmoil as well as no one really knows what the next step should be and how to deal with the overnight changes. In the meantime, rating agencies downgraded UK’s top notch rating and with this the problem of funding the huge current account deficit becomes stringent.
However, until the UK actually applies for leaving the EU, there is still the vague possibility that it will still remain in the union. But this is just speculation at this moment of time.
Because of this huge uncertainty, nothing from an economic point of view does matter anymore as speeches from Draghi, Yellen, or other central banks are becoming meaningless.
The ECB (European Central Bank) forum at Sintra, Portugal, started this week but speeches there unlikely to impress market as all eyes are on the steps the UK needs to take and when it will take them.
Coming back to the currency markets, I would say the US dollar is the main beneficiary of this situation and over the long term we may see smart money turning to the dollar. With this Brexit vote, there is almost certain that the Fed is not going to hike the rates anymore until the dust settles, but this does not mean that the US dollar will not rise.
As history shows us, it is very much possible to have a strong dollar in a US recession. I guess time will tell if that is going to be the case or not.