Here’s How I Would Trade the Upcoming French Elections

Announcement: On the next 2 Thursdays (11 & 18 May 2017), I will be conducting the last and final run of the “Trading Foundation Workshop”, after which I will be taking a break from training to work on a new big and exciting project. Don’t miss this last chance to catch me live!


The French election has been a hot topic among financial news outlets, but the hype around it doesn’t yet compare to that of Donald Trump last year.

It was a historic event that saw a roller-coaster in the markets during the exciting vote tallying nail-biter.

Here was how the USDJPY currency pair reacted as the votes were being counted. In the first 5 hours, Hillary was ahead in vote count and the USDJPY fell drastically. But as time went by, the USDJPY rose almost non-stop for 1 month.

 


The USDJPY currency pair 5 hours, 17 hours, and 3 days after the election outcome in the U.S.

In spite of the hype surrounding this event, it is unlikely to be as epic as Trump vs Clinton. France is indeed heading into the most unpredictable presidential election in decades; it is going to affect the EU’s second largest economy, but possibly also the direction of the EU itself. All eyes will be on the Euro currency and it is likely to be heavily traded during the announcement itself.

 

Here’s What You Need to Know

The First Stage of Voting: A candidate can theoretically win through primary contests, known as the first round of voting. He can actually win an election by securing 50% of the votes in this round, where mayors and other officials will vote, but this has not happened since the 1960s.

Two Weeks After the First Ballot: The first round vote took place on 23rd April, leaving two remaining candidates, while the second round will take play on 7th May. After 7th May, French voters will again vote on 11th June and 18th June to elect members of the National Assembly.

Young centrist Macron and populist right-wing Marine Le Pen.
Image Source: trbimg.com

No-Show: More than 22% of voters abstained from voting, the highest since 2002, which is worrying because Macron won 24% while Le Pen won 21.3% of the vote. The progress of the election has been said to mirror that of America last year.

Macron – Frexit-Advocate with Leftist Undertones

Macron recently warned the EU that it must change, or a Frexit, just like Brexit, would be soon to follow. However, he has carefully treaded between being a social support advocate and being market-friendly, a promise that is probably very challenging to deliver.

  • Working Hours: Re-evaluating the 35-hour work week, retirement ages
  • EU Policy: Suggesting that stronger nations within the eurozone engage in financial equalization (this is probably going to be done through budget transfers)

He also promises to “transform and not reform” France, and he has also promised to help a million jobless people find jobs. Among his other promises include removing the huge difference in public and private sector pensions.

The French are not happy with the current president, François Hollande, who chose to not run for reelection. Hollande belongs to the Socialists party, but the nominee of his party only garnered less than 7% of votes in a five-party race. At this point, the polls overwhelmingly show preference for Macron, but given the surprising situation in Brexit and the recent U.S election, uncertainty is likely to plague the minds of citizens and fund managers around the world.

 

Marine Le Pen – The Trump of France?

Recent polls project that Marine Le Pen isn’t expected to become president. However, she seems to represent the wave of populism sweeping across Europe, and a Le Pen victory

Polls show that the poor prefer Le Pen.
Image Source: Telegraph.co.uk

While there are many articles discussing Le Pen’s policies and how they will affect the nation of France, we can view Le Pen’s proposals as being nationalist and protectionist.

  • Stimulating Economic Growth: Government-led improvements in national industries
  • Reduce Bureaucracy: Reduce the size of government and wasteful welfare spending
  • Border Control: France to retake control of its borders
  • Currency Control: Reintroduce the French franc, to be used in circulation alongside the Euro

This resonates strongly with working class voters (I almost seem to be writing about the U.S election), for France has been plagued by high taxes and unemployment for years. She looks like the change that the average citizen is looking for.

 

The Uncertainty Ahead – What Traders Can Do

It is sad that the streets of Paris saw several clashes, and police officers were called to the scene. Three police officers were injured by petrol bombs thrown by rioters, and the police was forced to use tear gas on the demonstrators. It is strangely similar to the violence that surrounded Trump’s victory, but no one can conclude that this is definitely going to happen.

What’s certain is that volatility surrounding the election is going to be high, and several brokers have raised trading margin requirements ahead of the election. In any case, it would be wise to close out your trades and look to re-enter after the volatility. If you have longer-term positions, holding on to them may be a good idea because the market is unlikely to be as volatile as that of the U.S last year, and you are likely to remain unscathed.

  • Close out short-term positions, and look to re-enter after the volatility has ended.
  • Experienced traders can trade small and look for trend-following entries during the event, as forex markets might have prolonged directional bias. Watch closely how price behaves after any initial knee-jerk reaction.
  • Beginning traders are advised to stay away from trading during the election results announcement time.

 

P.S. On the next 2 Thursdays (11 & 18 May 2017), I will be conducting the last and final run of the “Trading Foundation Workshop”, after which I will be taking a break from training to work on a new big and exciting project. Don’t miss this last chance to catch me live!

Research Sources

france24.com/en/20170501-french-political-climate-mirrors-similar-USA-trump-election-surprise
dw.com/en/macron-promises-to-transform-not-reform-france/a-37778318
nationalreview.com/corner/447259/why-everyone-so-certain-about-weekends-french-election
thesun.co.uk/news/3453851/french-election-2017-emmanuel-macron-eu-france-frexit/
theatlantic.com/international/archive/2017/05/french-elections-2017-who-will-win/524775/
fxcm.com/insights/will-french-presidential-election-april-2017-affect-euro/

Will Higher Interest Rates Eventually Lead to a Stock Market Crash?

asJanet Yellen’s actions come into the spotlight once again.
Source: slate.com

 

After a slew of unprecedented events (Trump, Brexit), what has been troubling the world financial markets in recent days? As the FOMC announcement approaches, market participants have all eyes fixed on the almost-certain rate-hike that is coming up on Thursday. You probably have started to see Yellen’s photograph in news articles across all major financial newspapers.

Traditional economics theory teaches us that when interest rates rise, they are deflationary; businesses find it harder to borrow and affects interest-sensitive investment, while home owners find it harder to pay their mortgages. It all seems reasonable on the surface, but what actually goes on behind it?

In an economic climate such as ours today, traditional predictions have fallen very flat. There are Fed officials and scholars (not lay-people) who still insist that QE has no impact on the real economy whatsoever. The average wage-labourer probably doesn’t feel much when interest rates change, nor will he care even if rates drop or rise significantly.

However, as traders, our portfolios are at stake and it will bode us well to study this properly. Several macroeconomic indicators have to be understood and analysed to understand what is likely to happen. I’ve broken it down into 4 components for easy reading. Let’s get going:

INDICATOR #1: Falling GDP?

The body of scholastic material addressing the link between interest rates and GDP is rather depressing. Stephen D. Williamson summarizes this rather aptly:

“There is no work, to my knowledge, that establishes a link from QE to the ultimate goals of the Fed—inflation and real economic activity”-Stephen D. Williamson, St. Louis Fed Vice President

When the cost of borrowing rises, economic activity slows. That has been what the Fed was trying to do when it goes ahead and raises interest rates. They were used as a deflationary tool to keep the economy from expanding too rapidly. What have we seen? I came across this table while researching on this topic:

bank

What we see is that the average rate hike cycle takes 22 months, while a recession normally happens 41 months later. However, it has been 87 months since the last rate hike, eclipsing even the 85 months lag time since the 1994-1995 rate hike.
These are definitely unusual circumstances. While the economy has been chugging along for 7 years despite near-zero interest rates, I don’t see how a rate hike would dramatically change this, especially in the short-term (1-2 years from now). While the economy has been a big topic on Trump’s agenda during the election, the reality is that the economy is still reeling from the damage caused in 2008, and it could take far more than more investments to bring the world back to economic health.

 

INDICATOR #2: Lower Stock Prices?

The US stock market has been breaking new highs and with every new high, another analysts comes out and purports that ‘this is the top’.

 

econDire predictions by an economist.
Source: CNBC

However, before we all go into doom and gloom, let us remember that the bear markets of the last 50 years have had different causes, to be fair, there had to be some sort of trigger. It could be a political issue, such as the 1973-74 oil crisis, and the 1990 bear market caused by Iraq’s invasion of Kuwait. Furthermore, the Fed could be behind a market crash; in 1982, after raising interest rates relentlessly, the U.S market saw some severe bear moves in that period of time.

Sometimes bear markets happen because of bubbles; such as when the 2001 dot-com bubble and 911 terrorist attacks came about. In 2008, we saw a market crash as a result of a tanking housing market spurred by widespread institutional dishonesty.

Let us not be quick to jump to conclusions about a market crash coming. I’ll be watching the S&P and other indices closely over the next few months.

Interestingly, some quip that the “three steps and a stumble” rule would become a reality. It last happened in 2004, but we didn’t see a stock market crash until 4 years later.

“The ‘three steps and a stumble’ rule states that after three consecutive rate hikes (three steps), the stock market would begin to fall rapidly (stumble).”

I don’t quite buy into this idea. Over the past 30 years, there were only nine occasions where we saw 3 rate hikes in a row. Thrice in the 1970s, four times in the 1980s, and twice in the 1990s, and on average, only the 1970s saw a significant decline (approximately 10%) of the stock market in the next year or so.

chartChart of DJIA price changes after 3 rate hikes
Source: MarketWatch.com

More interestingly, the S&P500 looks like it’s ‘toppish’; the bull run seems rather unsustainable, but something seems to be sustaining this euphoria. On a technical basis, it has simply broken out of an expanding wedge on the daily chart.

sp
The S&P500 has broken out of an expanding wedge pattern. It looks rather unsustainable, but it is happening before our eyes.
Source: MetaTrader 4

We’ll have to watch closely how the S&P behaves near the resistance before deciding if it would continue the rally (which is very possible!).

 

INDICATOR #3: Volatile Bond Prices?

There are signs that the market has already adjusted to an interest rate hike. Check out what happened to the 30-yr Treasury Bonds over the past year or so:

30yr

The 30-yr Treasury Bonds have fallen 15% since its last high in July 2016.
Source: MetaTrader 4

The rude correction has shocked many bulls out of the market, and it seems we have entered bearish territory in the bond market. My opinion is that the rate hike has definitely contributed to this, but it seems that the rate hike is a mere response to the macroeconomic conditions of the world. On the technical side, we see a head and shoulders pattern that has broken down (as a result of election fever), and the downtrend has continued somewhat.

yieldsShort-term yields have risen almost as much as long-term yields.
Source: Bloomberg

If you’ve studied finance in university you would immediately recognize that the yield curve has flattened. Check out the table above; 3-month rates have risen as much as 30-year rates! This means 3-month yields have risen more than 100%, while 30-year yields rose about 10% or so. This is a typical response when the Fed tightens monetary policy.  A famous interpretation of the yield curve states that when yield curves get inverted (when short-term bonds yield more than long-term bonds), that’s when the stock market crashes like nobody’s business.

We are still very far off from an inverted yield curve, so a market crash is still some distance away. My guess is that the bond market, as a measure of fear, will be in a state of confusion as there are valid reasons for economic strength as well as economic panic. Volatility in yields is likely to be the norm in the year ahead.

INDICATOR #4: Commodity Prices

Although some pundits claim to be able to predict how interest rates will move commodities, I beg to differ. Oil, for example, is very much output driven (think OPEC), and recently we’ve been having output cuts among producers. As you can see in the image below, when I checked the newsmap yesterday, ‘Oil Surges as More Producers Join Output Cuts’ was the most-read news of the day.


A casual glance at the NewsMap reveals a heightened focus on oil production.
Source: Newsmap.jp

Generally speaking, if you look at the relationship between oil and real interest rates, we see very little correlation even over the very-long-term.

irIt’s hard to come to conclusions about how interest rates have affected commodity prices globally.
Source: cobank.com

More recently, we’ve seen commodity prices tank over the past 5 years despite interest rates remaining almost constant. I just did a simple google search on the price of DBC (the global commodity price ETF) and this is what happened in the past 5 years.

commm
A quick glance shows that commodity prices have fallen for 5 years.
Source: Google finance

To make an investment decision on commodities solely on interest rates isn’t wise. On a technical basis, commodities look like a good buy and I’ll be watching them closely to spot trading opportunities.

UP NEXT: THURSDAY’S RATE DECISION

If you aren’t already riding the bull market in stocks, it doesn’t make sense to enter now. Heroic bulls would want to enter now with a small profit target, and the world will be watching closely how the new year starts. Moreover, you won’t want to have too much exposure during the final FOMC meeting of 2016. Volatility on all other asset classes are expected, and I’ll be trading currencies, perhaps more regularly on an intra-day basis if I can’t find any good longer-term trends to ride on. All eyes will be on Thursday’s Rate Decision and the price action in the aftermath will be worth watching.

RESEARCH SOURCES & REFERENCES

http://www.cnbc.com/2015/09/15/when-the-fed-raises-rates-heres-what-happens.html
http://www.cnbc.com/2015/08/18/st-louis-fed-official-no-evidence-qe-boosted-economy.html
https://www.thestreet.com/story/13279476/1/what-happens-when-the-fed-hikes-interest-rates.html
http://www.slate.com/content/dam/slate/blogs/moneybox/2015/11/23/janet_yellen_responds_to_ralph_nader_s_sexist_letter/495620136-federal-reserve-chair-janet-yellen-testifies-before-the.jpg.CROP.promo-xlarge2.jpg
http://www.cnbc.com/2015/08/24/8-things-you-need-to-know-about-bear-markets.html
http://www.cnbc.com/2016/12/10/economist-harry-dent-says-dow-could-plunge-17000-points.html
http://www.marketwatch.com/story/edson-goulds-three-steps-and-a-tumble-rule
https://www.thebalance.com/inverted-yield-curve-3305856
http://www.cobank.com/Newsroom-Financials/~/media/Files/Searchable%20PDF%20Files/Newsroom%20Financials/Outlook/Outlook%202012/Outlook_10122.pdf

All You Need to Know About the Upcoming US Election: Past Trends, Possible Outcomes & Market Impact

us-electionsSource: IBTimes UK

The U.S Presidential election results will be announced On 8 November, where 66.82% of the 218,959,000 have registered to vote. This is much higher than in 2012, where 57.61% of eligible Americans decided to vote. The increased interest in the presidential candidates is unsurprising, but what does it mean for our portfolios? There’s so much buzz around this being a ‘historic’ event that we have to see how the markets are reacting to it.

Before we dive headlong into it, I thought it’ll be good to tickle our brains with a little general knowledge. So instead of simply knowing that Trump has a questionable moral compass or that Hillary has a private email account, let’s fill our minds with some cool stuff.

WHY IS THE ELECTION HELD ON 8TH NOVEMBER THIS YEAR?

possible-dates
Some say that America was an agricultural society and November (the quietest month) was most suited for the rural people. It could have been on Tuesday because people needed time to travel to towns and cities to vote, and some could not have done so in just one or two days. Sounds credible enough to me.

Election Day has always been the Tuesday after the first Monday of November. Based on this rule, it could only fall between November 2 to November 8.

The last time it was held on November 8 was in 1960, and 1988.

1960 Election Results
Candidate Party Electoral Votes Popular Votes
 John F. Kennedy Democratic 303 34,227,096
 Richard M. Nixon Republican 219 34,107,646
 Harry F. Byrd Democratic 15 116,248

1960 saw one of the closest margins in the election, with a mere 120,000 out of 68 million votes swinging the election in Kennedy’s favor. Sadly, he was assassinated in 1963 in the most high-profile murder of the 20th century.

1988 Election Results
Candidate Party Electoral Votes Popular Votes
 George Bush Republican 426 47,946,000
 Michael S. Dukakis Democratic 111 41,016,000

The 1988 elections were more one-sided, with George Bush (Senior) emerging a clear victor.

 

WHAT OUTCOME WILL GENERATE MORE UNCERTAINTY?

With Trump being the tough businessman and Clinton being the seasoned politician, the opinion of voters is very much predictable. You won’t even need to be a news analyst to understand how the general public views them. In the image below, it seems that Hillary has garnered more support in terms of her ability to handle the pressures of the Presidential office.

voteropinionSource: Huffington Post

 

In Europe, it seems that the consensus is that Trump would reap economic havoc, while Hillary would bring great relief. I can just imagine the great fear and trembling that people would feel if Donald Trump were the commander-in-chief, holding the codes for nuclear warheads being released around the world.

yougob

Source: YouGov

POSSIBILITY 1: BULLISH VIEW (MARKETS WILL RISE)

Well, that depends on which markets you are looking at. From a purely fundamental point of view, the market hates uncertainty and it seems logical to believe that markets will rise (by default) if Hillary was president. It agrees with the opinion that Hillary is unlikely to bring a lot of change to the White House, and that things will just continue chugging along.

I stumbled upon an article where an analyst seemingly guarantees that Gold would rise. Although I am bullish on Gold (in the long run) as well, I think that this election is not the key driver.

gold
Source: MarketWatch

As a trader, I always operate in a fog; one moment the market could be bullish, and the next moment the entire sentiment gets reversed. Of course, one can be of the view that Hillary will bring great relief to America and the rest of the world, but what would you do to your portfolio if markets behave otherwise?

 

sp

A cursory glance at the S&P 500 and Gold chart might lead you to conclude otherwise. In the short-term, Gold is not necessarily a safe haven, and it does not have a clear inverse relationship with the S&P 500 in recent years. In both charts above, we see that both seem to be topping out, and the S&P has even broken out of a recent wedge pattern. Gold is struggling to recover from a large breakout from its own wedge pattern as well.

POSSIBILITY 2: BEARISH VIEW (MARKETS WILL CRASH)

Among the many doomsayers out there, I do think there will be a reaction to the market but financial mayhem is quite a stretch. These people’s comments range from something as mild as “a sharp correction”, to “total financial destitution”. At the start of Obama’s term in 2008, he inherited a 34% dip in the Dow Jones Index upon being elected the President.

How much attribution will a “bad” president actually have on financial destruction? The crash of 2008 was the result of systemic banking failure. The crash of the Chinese stock market index in June 2015 was the result of an unprecedented increase in the number of stock pundits (customer brokerage account openings actually double and tripled in the years preceding the crash).

Using statistics of presidential elections since 1945, when the U.S stock market (S&P500) was increasing quickly, the incumbent candidate (Hillary) won 82% of the time; now that’s some pretty decent odds. But when the stock market was falling, the challenger (Trump) won in every election since 1984. While the S&P500 has been steadily rising since 2009, it is starting to look a bit toppish and had a slight correction in the last 1-2 months.

With Europe teetering on the edge of a recession, Trump’s policies could cause Europe to fall into a full-blown economic depression. That’s a real possibility. With his protectionist stance and nationalistic agenda, Trump could very well be the untimely catalyst.

 

POSSIBILITY 3: NEUTRAL VIEW (SIDEWAYS & MORE VOLATILITY)

There seems to be a consensus that volatility in markets will increase leading up to the election (before the mayhem happens, on the actual day, and also in the weeks to come). This makes the Pound interest rate announcement (on Thursday 8pm), and the Non-Farm Payroll announcement (Friday 8:30pm) pale in comparison. My take is that the election has generated far greater anticipation in the financial markets, and these two news events would be a tremor compared to the earthquake that might come.

vix

In the chart above, the VIX has risen steadily for the past week.This is the first time we’ve seen a steady increase in volatility over 7 days; a steady increase like this has not happened for the whole of this year.

POSSIBILITY 4: NEGLIGIBLE MARKET IMPACT (UNLIKELY)

hillarytrumpmemeSource: Kappit.com

With Trump’s tough stance on immigration and trade, his intention to renegotiate the North-American Free Trade Agreement (NAFTA) and scrap the Trans-Pacific Partnership (TPP), the mere mention of such a stance would likely send jitters into emerging markets.

Of course, there are those of the camp that America couldn’t care less about a president, because the world is in a state of low-growth and inflation. Experts have said this is a global Japan-style stagflation and that these conditions mirror those in the 1970s.

HOW DID THE MARKETS FARE IN PREVIOUS ELECTIONS?

A Princeton Research Paper found that GDP growth under a Democrat President (Hillary is a Democrat Candidate) is 1.80% higher, on average, than a Republican President (Trump is a Republican Candidate). This suggests that a Hillary win would be more bullish for markets.

Another famous theory by Yale Hirsch states that U.S. stocks see the smallest gains in the year after an election. The market more often improves after the first year following the election year. Ned Davis Research claims that “since 1900, stocks have gained just 3.4% on average in the post-election year, compared with gains of 4.0% in the midterm year, 11.3% in the pre-election year and 9.5% in an election year.” (This is summarized in the graphic below)

yearsSource: Ned Davis Research

 

With Trump consistently trailing behind Hillary just marginally, markets are going to be in a jittery state in the days to come. The last I checked (on 31 oct), the gap has closed to just 2.1% in the polls:

31octresult

 

STRATEGY & COMMENTS

In the most recent FOMC meeting (3rd November 2am SG time), the interest rate remained unchanged, which was expected since they are unlikely to want to rock the markets further just prior to the elections. The next major piece of news is the NFP on Friday, and for traders who have decided to hold any major medium/long-term positions over the election, this could be a good opportunity to take positions at better prices. This is because the NFP is likely to cause price spikes, but markets are likely to stabilise and flat out rather than trend strongly before the US elections next week.

Based on my personal views (this is not any recommendation to follow), I would prefer to take a bearish position (short) on the S&P 500 going into the election, as I feel that there is more downside potential in general, and the market is more “priced in” for a Hillary win, meaning a Trump win would have more spectacular returns. My plan is to make use of the NFP to enter my positions, for example if the NFP causes an intraday bullish spike in prices, I will use the opportunity to accumulate shorts at more favourable prices. This will enable me to reduce my risk and increase my upside.

Good luck, and may the odds be in your favour! 😀

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RESEARCH SOURCES & REFERENCES

http://www.270towin.com/1960_Election/
http://www.270towin.com/1988_Election/
https://www.timeanddate.com/holidays/us/election-day
http://www.telegraph.co.uk/news/0/when-is-us-election-2016-what-is-the-timetable-for-the-night-and/
http://www.nbcnews.com/politics/first-read/nbc-wsj-poll-clinton-jumps-nine-point-lead-over-trump-n623131
http://www.cnbc.com/2016/10/31/a-trump-win-could-put-emerging-markets-in-a-tailspin.html
http://abcnews.go.com/Business/story?id=6185252&page=1
http://www.kiplinger.com/article/investing/T043-C008-S003-how-presidential-elections-affect-the-stock-market.html
http://www.investopedia.com/terms/p/presidentialelectioncycle.asp
http://www.independent.co.uk/news/world/americas/us-elections/us-election-donald-trump-victory-stock-markets-sp-republican-party-senate-a7392756.html

How Will Brexit Affect the Various Markets?

Last week, there was much turmoil and excitement in the market. Fortunes were made and lost. And many markets spiked strongly, hitting record new highs or lows.

The pound has crashed more than 12%.

1

 

Gold rose more than 5% in a day:

xa

 

And Oil has started to tip under the 20-EMA (daily chart):

oil

 

The ASOS site crashed as too many shoppers started to buy on the cheap pound.a

Fox news network wrongly reports that the UK has left the United Nations:

fox_news_brexit.jpg_1611819713

 

It seems that almost anything that deals in pounds or derives revenues from the UK is at risk of being dumped. For example, Comfortdelgro runs bus and taxi services in the UK, deriving more than 20% of its operating profit there.

The STI has rolled over on the daily chart, and is convincingly under the 20-EMA.
sti

But on the multi-year chart, if we zoom out a lot we see it has quite a bit of room to move down before it can be considered a bargain buy. I’ve talked about it in my previous workshops, when I showcase my 30-year forecasting chart for long-term investors.

stii

 

There’s a lot of talk about the Brexit being a financial snowball that will end in financial mayhem. There are also people on the internet talking about a huge correction in real estate prices in Singapore:

asd

Overall, I’m glad I stayed out of the Brexit and closed all my positions prior to the Brexit (last wednesday!). Having announced it on my private “live” chat to my program graduates, I sat back and calmly watched the world burn. Just kidding! 😀

fb

What’s clear to me is that although the charts look a little ugly at the moment, the STI is still not undervalued.

For example, China Aviation still remains sky high, after having taken profit on a 5.83 R/R trade (meaning I made 5.8 times of what I risked for the trade):

Here’s the screengrab of when I took the trade,

chinaaa

 

And where it ended up last Friday. Looks like a really nice bounce setup but that’s for another time.

china

 

For now, since most charts are kind of messy and prices and in the middle of the spike range, I will be focusing more in intraday scalping trades to have consistent income even during such volatile times.

This is a defensive play, so instead of going for big wins, I am going for many small wins instead. Good luck!

 

Sources:
http://www.telesurtv.net/english/analysis/Trump-and-4-Other-Crazy-Things-That-Happened-over-Brexit-20160624-0026.html
http://sbr.com.sg/residential-property/in-focus/here%E2%80%99s-why-brexit-bad-news-singapore-property

The Brexit Debate – What are the Possible Outcomes?

The ongoing Brexit Debate has been keeping markets around the world jittery for the past few days, especially the Pound (GBP), which has been declining sharply for the past 2 weeks.

The date that everyone is looking out for is 23 June, where the referendum will take place, with the big question, “Should the United Kingdom remain a member of the European Union or leave the European Union?”

Prime Minister David Cameron wants Britain to stay in the EU. US president Barack Obama also wants Britain to remain in the EU, as do other EU nations such as France and Germany. But according to polls, the British public seems pretty evenly split on the issue.

brexit

From what I see, the Brexit (Britain + Exit) is a unique situation that could develop into one of three paths.

PATH 1: TOTAL INDEPENDENCE (UNITED STATES MODEL)

One possible arrangement is for Britain to be completely independent of the EU. This would make Britain as “separate” as the United States. Among the chief concerns would be the hefty protectionist taxes levied on U.S exports. It is widely-known that American cars are more expensive in Europe than those sold in America. Some dooms-day economists claim that this could lead to disaster for Britain’s already negative trade balance.

1

Source: tradingeconomics.com

If you follow this line of reasoning you might expect the pound to become like the current depreciated USD. A country cannot have sustained deficits without experiencing a sharp fall in its currency value in the long run.

PATH 2: PARTIAL INDEPENDENCE (NORWEGIAN MODEL)

Another possibility is for Britain to leave the EU but remain in the EEA (European Economic Area). David Cameron seems to be very pessimistic about the Brexit, citing concerns of pensions, the healthcare budget, and the defense budget; which he feels would all be adversely affected. This option is a compromise between the two extremes, and it is called the Norwegian model.

In return for access to the EEA, Britain will then have to comply with the EU’s law relating to the internal market. However, Britain will not have a say on the rules that are made in the EU.

PATH 3: NEGOTIATE A TRADE DEAL (HIGHLY UNLIKELY)

Britain can negotiate for a trade deal that would allow certain goods to be exported freely to the EU. However, this is highly unlikely to happen as the EU would also demand for the labor market to be opened up (to immigrants and asylum seekers), which is clearly something the Brit voters do not want.

 

gbpusdDaily Chart of GBP/USD

HOW TO TACKLE THE MARKET?

As with most unique news events, the markets will start trending based on anticipated outcomes, and remain inactive as traders start to close out their positions to stay on the sidelines. Many brokers have increased the margin requirements in anticipation of a huge move.

For me, I personally do not like to trade on such news, as there will be huge spreads and slippage when the market is moving too fast. Hence, I will likely scale out of my existing positions and take profits off the table as we get nearer to 23 June.

If I were to take a gamble, I would go long on the Pound (GBP), firstly because it has already dropped quite a lot to “discount” the possibility of a Brexit, and secondly because I think that Britain is more likely to stay in the EU. These are just my random musings. 😀

Good luck!

 

Sources:
http://www.bbc.com/news/uk-politics-32810887
http://www.bbc.com/news/uk-politics-eu-referendum-36511598