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Currency Markets May Pause to Digest After Brexit Fireworks

Talking Points:

  • British Pound continues to sink as “Brexit” aftershocks plague the markets
  • Yen and US Dollar gain, commodity currencies gap lower at trading open
  • Risk sentiment trends may transition into corrective mode in the near term

Aftershocks from last week’s Brexit-inspired volatility continued to define currency market price action at the start of the trading week. The British Pound continued to underperform, losing around 2 percent against the majors. The sentiment-linked Australian, Canadian, and New Zealand Dollars traded downward while the safe-haven US Dollar and Japanese Yen dutifully moved in the opposite direction.

With the first act of the “Brexit” drama now behind them, the markets now face a long and uncertain path toward reckoning with the aftermath. This is likely to be measured in months and years, not hours and days. In the immediate term, this may translate into a short digestive pause after last week’s explosion of volatility. Still, European and US stock index futures are pointing sharply lower in late Asian trade, warning that risk-off momentum aims to carry forward.

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Asia Session

European Session

Critical Levels

— Written by Ilya Spivak, Currency Strategist for DailyFX.com

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Realization of Brexit is a Potential Nightmare for the Euro

Realization of Brexit is a Potential Nightmare for the Euro

Fundamental Forecast for EUR/USD: Bearish

- Prospect of European Union breakup reenters the conversation.

- A new regime of higher volatility has arrived thanks to the UK’s Brexit vote.

- FX market volatility will remain elevated after UK-EU referendum – it’s a good time to review risk management principles.

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What was once a seemingly meaningless short-term political compromise for David Cameron has now morphed into the potential to be a living nightmare for the Euro: the United Kingdom has voted to leave the European Union. If you recall in the run-up to the May 2015 General Election, then-UK Prime Minister Cameron promised to hold a referendum on the UK’s membership in the EU in order to appease the right-wing of the Tory party and the rising swell of UKIP. It’s proven to be a costly political gamble that has roiled global markets, and will influence the Euro for months and years to come.

There is no reason to undersell this moment. There were clear signs over the past few months over the potential impact of a Brexit on the Euro, such that the rapid depreciation in the Euro after the Brexit vote shouldn’t be a surprise. Indeed, starting in February 2016, the Euro started to become increasingly sensitive to Brexit-related headlines, shadowing the British Pound’s decline. By the end of Q1’16, markets globally, especially the Euro, were proving vulnerable to Brexit fears. Accordingly, we titled our Q2’16 Euro forecast, “EUR/USD Stuck in No-Man’s Land Headed into Q2’16; Don’t Discount ’Brexit’” in anticipation of the growing risk. As we said at the time, which is proving true now, is the Euro is having a “political moment.”

The whole premise of the European Union project, going back to its humble beginnings rising from the ashes of World War II as the European Coal and Steel Community, was to promote an economic vision of a unified Europe where, regardless of the language you spoke, the country you lived in, or culture you partook in, you were a European at heart. When we fast forward to present day, the implications of a Brexit are significant at a time when (1) a crippling debt crisis has sapped sovereignty from peripheral European countries, (2) the Syrian Civil War has produced an uncontrollable wave of refugees that has revealed infrastructure issues and (3) considerable security concerns to the point that countries have threatened to renege on their Schengen Area duties to close their borders.

The very heart and soul of Europe is at stake from a litany of perspectives; the uncertainty around the answers to these questions means volatility for the Euro.

As we said each of the past two weeks as Brexit tensions mounted, the Brexit component for the Euro is clear: it raises the question of how permanent being a member of the European Union actually is. If the British are allowed to leave the European Union, recent polls from various countries – peripheral and core alike – have showed that populist backlash against the pan-European project is growing. Polls have emerged from Germany, Holland, and Italy in recent weeks that suggest at or near 50% of citizens would support a UK-like referendum regarding their own respective memberships; indeed, in the hours (minutes? seconds?) after the Brexit vote was announced on Friday, politicians in Italy, France, and Holland all called for UK-like referendums in their own respective countries.

The Spanish election results on Sunday are a promising vote of confidence from the Euro-Zone’s fourth-largest economy, if not a sign of a population that has heeded the Brexit fallout as a warning. The main Spanish stock index fell by over -12% on Friday, its largest single day loss in over thirty years – yes, a sharper selloff than anything seen during the depths of the height of the 2008 GFC.

Table 1: Probability of Rate Cuts to ECB’s Main Refinancing Rate (OIS)

Realization of Brexit is a Potential Nightmare for the Euro

Volatility in markets and the uncertainty around the long-term viability of the EU will likely put a small but noticeable chill on economic activity, which conveniently gives the European Central Bank cover to ease further, something the Euro-Zone desperately needs. Overnight Index Swaps markets have dragged forward expectations for a rate cut by September 2016 (62%), suggesting that markets feel liquidity assistance will be necessary as uncertainty persists (there are signs of funding pressures increasing). Anticipation of ECB action could weigh against the Euro, as it has done consistently over the past five years.

Chart 2: Implied Probability of ECB Main Refinancing Rate by Meeting

Realization of Brexit is a Potential Nightmare for the Euro

Moving forward, there’s increasingly less certainty given the complexity and significant implications of the Brexit vote. Somewhat positively, the market reaction on Friday may have served as a warning sign of how the world feels about leaving the EU (not good!), which may have helped the Spanish elections. Other populations may be less apt at sprinting to the exit. If the Brexit vote serves as a wake-up call to fiscal policymakers in Europe, then this may help catalyze an ‘ever-closer union’ that survives this episode (somewhat redundantly and obviously, long-standing political institutions have to survive crises, otherwise they wouldn’t survive; the United States weathered the Civil War, for example).

In the meanwhile, don’t expect the market to settle down in the near-term, or really any time soon. What this means is that recent trends are likely to persist; it’s too early to catch the falling knife or attempt to be a hero. One such way to gain an edge is to monitor retail crowd positioning (analogous to commercial hedgers in the futures market), as the crowd has consistently been on the wrong side of these recent big moves. The fact that the retail crowd remains net-short EUR/USD and EUR/JPY is just another reason to maintain a high degree of skepticism towards the Euro in the near-term, beyond the understated political, economic, financial, and geopolitical implications of the historic Brexit vote. –CV

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Reread our Q2’16 Euro Forecast, “EUR/USD Stuck in No-Man’s Land Headed into Q2’16; Don’t Discount ’Brexit’”

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Crude Oil, Gold Prices Aim in Opposite Directions After Brexit Jolt

Talking Points:

  • Crude oil prices decline most in 4 months amid risk aversion
  • Gold prices spike to 2-year high on UK referendum outcome
  • Commodities may take on consolidative tone after Brexit jolt

Crude oil prices fell alongside stock prices while gold prices surged amid last week’s Brexit-fueled risk aversion. More of the same continued after the weekend. The WTI contract mirrored weakness across Asian equities while gold traded upward with near-perfect inversion.

Looking ahead, the spotlight turns to Sintra, Portugal. The world’s top central bankers are gathering for an ECB forum, offering an opportunity for seemingly inevitable post-Brexit referendum commentary from Fed Chair Yellen, ECB President Draghi as well as BOE and PBOC Governors Carney and Zhou, respectively. Short of the unlikely appearance of policy specifics however, the markets are unlikely to be materially inspired even by such giants of global policymaking.

The unprecedented secession of an EU member state with its many lingering uncertainties look set to prolong the risk-off mood. Hinting as much, European and US stock index futures are pointing sharply lower in late Asian trade. A degree of consolidation is also a reasonable scenario however. The immediate event risk has passed and now the Brexit drama transitions into the slog of dealing with the particulars. There seems to be some room for reflective digestion.

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GOLD TECHNICAL ANALYSISGold prices accelerated upward having put in a bottom below $1200/oz as expected, spiking to a two-year high. A daily close above the 61.8% Fibonacci expansion at 1321.79 paves the way for another test of the 76.4% level at 1338.72. Alternatively, a reversal below the 50% Fib at 1308.12 exposes the 38.2% expansion at 1294.44.

Crude Oil, Gold Prices Aim in Opposite Directions After Brexit Jolt

CRUDE OIL TECHNICAL ANALYSISCrude oil prices put in the largest daily decline in four months. From here, a break below the 23.6% Fibonacci retracement at 45.60 targets the 38.2% level at 41.86. Alternatively, a move above resistance in the 48.73-50.18 area exposes the 23.6% Fib expansion at 51.86.

Crude Oil, Gold Prices Aim in Opposite Directions After Brexit Jolt

— Written by Ilya Spivak, Currency Strategist for DailyFX.com

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Brexit Aftermath Analysis Directory

The UK has opted to leave the European Union, triggering record-breaking volatility across global financial markets.The British Pound registered the largest one-day drop on record against the US Dollar. Risk appetite collapsed, with the benchmark S&P 500 index plunging as US Treasury bond yields fell by the most since 1998. The anti-risk Japanese Yen and US Dollar soared against their G10 FX counterparts and gold touched a two-year high.

How did it happen? What’s next for the UK, the British Pound, and financial markets at large? See the full collection of DailyFX content on this historic event and its aftermath below.

We studied the traits of successful traders. This is what we found.

Brexit Vote – Initial Reactions

European Market Reactions as London Opens Post “Brexit” Decision – 06/24/2016

Chaos in the Markets as UK Votes to “Brexit” From the EU – 06/24/2016

UK Votes for Brexit – Markets Highly Volatile – Caution Advised – 06/24/2016

Brexit Aftermath: Where to Now?

Brexit Bloodbath Has Markets Betting on Lasting Volatility Risk – 06/24/2016

Technical Analysis

GBPUSD, EURUSD & Gold Technical Outlook in a Post Brexit World – 06/24/2016

CAC 40 Dives on Open – 06/24/2016

USD/JPY Retail Sentiment Moves Back to Extreme With Japan Watching FX – 06/24/2016

How did we get here? See our pre-Brexit analysis directory.

Brexit Aftermath Analysis DirectoryBrexit Aftermath Analysis Directory

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GBPUSD, EURUSD & Gold Technical Outlook in a Post Brexit World

  • Key technical levels on the back of the historic Brexit vote
  • Updated targets & invalidation levels
  • Compete to Win Cash Prizes with FXCM’s Forex Trading Contest

The implications of today’s Brexit vote will be far reaching and long-lasting as markets awaken to the dawn of a new day for Europe. From a trading standpoint, these unprecedented events make for difficult trading conditions as thin liquidity and vast daily trading ranges renders the near-term technicals of limited utility. Accordingly, it is prudent to use this time to reflect on the bigger picture to offer some clarity amid the chaos of these historic moves. With that said, here are some longer-term charts to consider and key levels we’ll be following on SB Trade Desk in the wake of the UK Referendum. Keep in mind more volatility is expected as US markets come online and we’ll want to see the dust settle before operating on these pairs- for now, we’ll be looking for reactions / inflections in price around these defined levels.

GBPUSD Weekly

GBPUSD, EURUSD & Gold Technical Outlook in a Post Brexit World

Chart Created Using FXCM Marketscope 2.0

Notes:Sterling covered the entire 2016 range in one day with the pair rallying into channel resistance before reversing sharply to post its largest daily range in history. The low registered just below the 100% extension extending off the 2014 high at 1.3303- note that this level also converges on a trendline extending off the 2001 & 2009 lows as well as the median-line (blue). Interim resistance stands at 1.3834 (a weekly close below bodes well for continued weakness) with our broader outlook weighted to the downside while below 1.4222/25 where the February low-day close converges on the 2010 low. IF cable has bottomed, look for a breach of this level to clear the way for a rally back towards the upper parallel. A break below the 1.33 targets the 1.30-handle backed by the 1.618% extension at 1.2457.

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EURUSD Weekly

GBPUSD, EURUSD & Gold Technical Outlook in a Post Brexit World

Notes:Euro has been trading within the confines of a well-defined descending median-line formation extending off the 2009 high and despite the Brexit volatility, the pair continues to hold within its yearly trading range. Support rests with the 2015 low-week close at 1.0814 with a break below trendline support targeting the 1997 low backed by the 76.4% retracement of the 2000 rally at 1.0051. Interim resistance is eyed at the 100% extension at 1.1435 with a breach of this consolidation formation targeting the median-line and a Fibonacci confluence at 1.1767-1.1810. From a trading standpoint, we’ll want to be mindful of the weekly close with the pair currently trading between the 52 & 13-week moving averages- again here a close below would keep the downside-bias in play.

Gold Weekly

GBPUSD, EURUSD & Gold Technical Outlook in a Post Brexit World

Notes: Gold rallied into long-term structural resistance extending off the 2011 record high before reversing sharply amid ongoing divergence. The weekly close will be critical here and a close sub-1311 would leave the long-bias vulnerable heading into next week. Look for interim support at the 50-line (currently ~1255) backed by the ML extending off the July 2015 low. Subsequent support targets at 1202 & 1166 with key support at 1166/68. A breach / close of above channel resistance is needed to keep the long-bias in play targeting 1380, 1433 & the 50% retracement at 1483. Continue tracking this setup and more throughout the week- Subscribe to SB Trade Desk and take advantage of the DailyFX New Subscriber Discount.

Help fine-tune you entries, click here to learn more about the DailyFX Grid Sight Index (GSI)

—Written by Michael Boutros, Currency Strategist with DailyFX

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Join Michael for Live Scalping Webinars on Mondays on DailyFX and Tuesday, Wednesday & Thursday’s on SB Trade Desk at 12:30 GMT (8:30ET)

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Brexit Bloodbath Has Markets Betting on Lasting Volatility Risk

Talking Points

  • Financial markets come undone as UK opts for “Brexit”
  • Record-setting volatility recorded across asset classes
  • Markets envision drastic volatility risk in months ahead

Financial markets were caught wrong-footed as the UK opted for “Brexit”, with voters deciding by a 51.9 to 48.1 percent margin to take the UK out of the European Union. FX options suggested traders priced in a mere 19.6 percent probability of what has now transpired on the eve of the momentous referendum.

Short-term projections hinted at what may transpire in a Brexit scenario last week as polling data narrowly favored a victory for the Leave campaign, with one-week GBP/USD implied volatility readings surging to the highest level on record. Qualitatively speaking, this foreshadowed what occurred today.

Brexit Bloodbath Has Markets Betting on Lasting Volatility Risk

The British Pound traded down nearly 8 percent against the US Dollar ahead of the opening bell in Europe, the largest one-day drop on record. Aggressive volatility would not be limited to Sterling however: the anti-risk US Dollar and Japanese Yen saw their largest moves since the 2008-09 financial crisis.

Brexit Bloodbath Has Markets Betting on Lasting Volatility RiskBrexit Bloodbath Has Markets Betting on Lasting Volatility Risk

The carnage would not be contained within the FX space. Gold prices also saw their largest daily gain since the Great Recession as shocked investors scrambled for refuge. Benchmark measures of market mood also came unhinged. On the pro-risk side, S&P 500 futures dropped by the most in 10 months. On the opposite end of the spectrum, haven flows drove bonds up so sharply that the 10-year US Treasury yield fell by the most in over seven years.

Brexit Bloodbath Has Markets Betting on Lasting Volatility RiskBrexit Bloodbath Has Markets Betting on Lasting Volatility RiskBrexit Bloodbath Has Markets Betting on Lasting Volatility Risk

The blood-letting is almost certainly just beginning. Indeed, an index of implied 3-month volatility readings for the world’s most-traded currencies jumped by more than 20 percent in the referendum’s aftermath, marking the largest daily gain since at least 1998. That sends a clear message: investors beware.

Brexit Bloodbath Has Markets Betting on Lasting Volatility Risk

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— Written by Ilya Spivak, Currency Strategist for DailyFX.com

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