Next Week's FX: Fasten Your Seatbelt

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 Britain’s decision to leave the European Union triggered pandemonium across the financial markets. Currencies and equities were hit hard by the vote with sterling falling over 10% intraday. Friday was the worst day ever for the British pound and the 1.3230 low reached during the Asian trading session was the weakest level for GBP/USD in more than 3 decades. The last time we had a move this large was during the Global Financial Crisis and, before that, on Black Wednesday when the U.K. government was ejected from the European Exchange Rate Mechanism (ERM). Brexit will be worse than Black Wednesday – we see that in the price action of currencies and gilts and in the level of uncertainty in the market. Ten-year Gilt yields fell to their lowest level ever. Britain needs to invoke Article 50 to redefine its relationship with the EU but leaders of the 'Leave' campaign refuse to act quickly. The longer they wait, the worse it will be for sterling. The only U.K. market to survive with modest losses was the FTSE 100, which ended the day down only -3.15%. The index dropped as much as 8.7% intraday but pared its losses on the back of a weakening pound and hope for U.K. stimulus.

But the bloodbath isn’t over for the British pound because Brexit is the beginning and not the end of England's problems. The next step is for the UK and EU to negotiate exit terms. And that will take months, possibly years. During this period, multinational businesses will refrain from making major investments in the U.K. economy and may in fact actively plan to move their headquarters and business operations over to the continent. There’s no question that during the next 12 months, the U.K. economy will pay dearly for Brexit – they’d be lucky if there was any growth at all in the second half of the year. S&P could strip its AAA rating and the Bank of England stands ready to cut interest rates if there is even a hint of recession. Thousands of words could be written about how damaging Brexit is for the U.K. economy but as currency traders, our main focus is the outlook for sterling.

GBP/USD ended “Black Friday” 400 pips off its lows, which is impressive given the severity of the country’s decision to abandon the European Union. In the days after Britain was forced out of the ERM, sterling fell another 5% and in the 2 months that followed, it was down 15%. So while we’ve seen an intraday recovery in GBP, we still expect Friday’s low to be revisited and broken. At minimum we expect GBP/USD to drop to 1.32 over next month, but the move could occur as quickly as the coming week. With no major U.K. economic reports scheduled for release, Brexit will continue to be the main story for the markets. When the U.K. decides to invoke Article 50, there could be a relief rally, but don’t be mistaken, that move should be sold into because the divorce from the EU will be messy.

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