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Brexit risks for the UK and the EU

Market Analysis
United Kingdom and European union flags combined for the 2016 referendum

Discussion about a possible Brexit have focused mostly on the UK and the economic impact on the country. The country would face a period of uncertainty and a recession – at least for a period of time. A major source of uncertainty is the fact that the UK would need to renegotiate its trade agreements. The time it would take to negotiate new trade agreements with various countries isn’t the only reason for concern from the UK’s perspective, but the quality of these agreements might be questionable as well.

For instance a trade agreement between Switzerland and China came into force in 2014. This agreement guarantees free access for Chinese products in Switzerland, but the Swiss still pay a tariff for Swiss watches exported to China. Therefore, not only could it take several years for the UK to negotiate the trade deals, but there is also no guarantee that the results would be better for British businesses than the current arrangements negotiated by the EU.

This has caused worry, especially amongst small and medium sized businesses, where a period of several years of uncertainty and higher export costs would eat into their profits and could force them to downsize, thus increasing unemployment. However, on the whole, the UK’s economy is much stronger than most of the European Union. This is why for the nation as a whole, the departure from the EU should be only a short-term nuisance when compared to the impact it could have on the EU, which might actually disintegrate as a result.

For the European Union, a Brexit could be an existential threat
While Greece’s potential exit from the EU in 2015 was seen as a risk for further disintegration amongst the European Union countries, a major country like the United Kingdom leaving the European Project would be catastrophic. According to Germany’s finance minister, Wolfgang Schäuble, a Brexit would seriously hinder further integration in the EU. This has caused substantial worry to EU leaders, as they know that in order for the euro to survive, the European Union has to do the opposite and increase integration. A common fiscal policy and common expenditure policy, together with a common government are the only way forward if the ailing currency area is to be kept alive.

Another serious issue that would emerge from the Brexit is the fear that other countries could be soon arranging their own referendums, which could lead to further break-up of the EU community. Simply put, Brexit would likely mean the beginning of the end for the European Union.

Recently the Leave camp has been gaining in the polls which have been pressuring the pound. GBPUSD has dropped almost three percentage points since May 26th while GBPJPY is down by 7.5% over the same period, while the safe have asset Gold has rallied over 5%. The markets were clearly worried about the possibility of Britain leaving the EU. Then something tragic happened.

Our view (first published in the 2016 Outlook) has been that the views promoted by the Leave camp will not be the main drivers in this referendum as the basic need to vote for something that is safe and familiar will dominate, while the benefit that is potentially to be gained from the Brexit is not clear to voters. The incentive just isn’t strong enough to move people to vote against the relative comfort of the current status quo. This view has been challenged by recent developments in the polls. However, yesterday’s tragic murder of a British pro-EU member of parliament is likely to sway the public’s opinion to favour the Remain camp.

Even if Gold was at resistance yesterday while US and European stocks were at support the fact that gold failed to rally against the USD while stocks, sterling and euro rallied indicated that the market participants perceived the tragic murder of English pro EU MP Jo Cox as being supportive of remain camp stance. The strength of the rally and the moves in the above asset classes make it seem that markets now see the Brexit risk is lower.

Quilty by association?
It is likely that the British voters will now associate the rage that motivated the murderer with the Leave campaign and express their protest by voting to stay in the EU. This is not fair on the Leave campaign but often people associate things quite illogically when they are under strong emotional influence. Both EU referendum campaigns have been suspended following this tragic event and could even stay suspended until the Referendum date.

Apart from the emotional trauma caused by this cruel act, the Remain camp’s view is supported by the uncertainty related to trade and legislative issues. As no one knows how long it would take to negotiate new trade agreements and what the quality of those agreements would be, it is hard to imagine that the businesses that depend on a certain level of visibility that enables them to plan their future would be willing to take such risks and vote against the EU membership. Then, on the other hand, employees for the most part are likely to realise that such uncertainty combined with a probable economic recession would lead to staff layoffs and higher unemployment and are therefore prone to vote for the continuum of current circumstances. When the potential legislative hurdles are added to the mix it is even more unlikely that the voters feel courageous enough to vote for an option that could seriously rock the economic boat.  According to the UK House of Commons research, EU-related law makes up at least a sixth of the UK statute book. While agreeing upon what legislation would be kept and what abandoned could be a beneficial exercise, the sheer size of the job is too overwhelming.

In the light of the above we feel supported in our view that the British voters will rather accept the current status quo in all of its imperfections rather than vote for an option that would almost certainly bring about a period economic uncertainty and possibly even a recession.

Risk reduction
However, due to the increased risk of high volatility we advise our clients to be cautious and avoid leveraged positions or refrain from having market exposure altogether immediately before and during the event. This is a major political event that is expected to impact the financial markets strongly and may result in high volatility, price gaps/spikes, lack of liquidity, widened spreads or other movements in the markets.

HotForex has as a company taken steps to limit the risks and the potential impact from the event. Please be therefore informed that today, Friday the 17th of June at market close, the margin requirements for all GBP pairs will be increased to 4% (1:25). In addition all remaining forex pairs and gold margins will be increased to 2% (1:50). This will be applied to existent and new orders and to all accounts no matter their current leverage. Please see the UPDATE on this issue on June 20th: Link

As a result of the above mentioned adjustments we kindly request that you please evaluate your current positions and calculate whether further funding will be necessary to maintain your open positions. We strongly advise you to perform the necessary funding actions well in advance, in order to ensure your account will be well-funded before the referendum takes place.

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Janne Muta

Chief Market Analyst

HotForex

Disclaimer: This material is provided as a general marketing communication for information purposes only and does not constitute an independent investment research. Nothing in this communication contains, or should be considered as containing, an investment advice or an investment recommendation or a solicitation for the purpose of buying or selling of any financial instrument. All information provided is gathered from reputable sources and any information containing an indication of past performance is not a guarantee or reliable indicator of future performance. Users acknowledge that any investment in FX and CFDs products is characterized by a certain degree of uncertainty and that any investment of this nature involves a high level of risk for which the users are solely responsible and liable. We assume no liability for any loss arising from any investment made based on the information presented here.