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How Pound May Follow Euro's Lead with Persistent Brexit Fear

How Pound May Follow Euro's Lead with Persistent Brexit Fear

2016-08-16 02:46:00
John Kicklighter, Chief Strategist
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Talking Points:

  • The Pound suffered one of its largest single-day declines in history after the Brexit and maintained those losses
  • Futures speculators are holding a record short view on the Sterling and sentiment remains deeply embroiled
  • Offering some proxy in fundamental pain, speculative positioning and lack of timeline is the Euro circa 2010/2012

See how retail traders are positioning in GBP/USD, EUR/GBP and GBP/JPY using the SSI readings on DailyFX's sentiment page. See the DailyFX Analysts' 3Q forecasts for the Poundin the DailyFX Trading Guides page.

The Cable is slowly marching back towards the three decade lows the pair set last month in the aftermath of the calamitous fall following the Brexit vote. The plunge from the British Pound is well founded as the path forward for the UK economy and financial system are disturbingly unclear. However, the markets rarely project the worst-case scenario unless there is tangible evidence of the disastrous fallout coming through the data. With the UK's decision to leave the EU, the actual process of separation has yet to begin. The impact is therefore purely speculative - whether decided on the view offered by sentiment surveys or speculators.

While the initial tumble in the Pound is defensible from a value perspective, it will be difficult to find consistency in further depreciation from the rank and file moving forward without definitive milestones to anchor the view. We have seen a similar shift in dependency to outright speculative outlook before many times in history, but the most appropriate comparison can be drawn to the Euro. Back in the early part of this decade, the Euro-area fell into a financial crisis that resulted in the need to bailout a number of its members and a seemingly permanent economic depression for Greece. While the extremes of an imminent collapse for the Eurozone were successfully diverted, the situation hardly reset to 'normal' when the Euro started to climb into recovery in the second half of 2010 and 2012.

After a while, the threat of an ever-present crisis in the Euro-area anesthetized the market to its impact. The Euro would in turn find its direction from other venues. That is likely to happen for the Sterling as well when it comes to the Brexit...and the acclimation will likely occur far more quickly. The time frame for material progress on the UK's withdrawal from the EU is long - likely before Article 50 is triggered and the two year period that follows. If economic conditions don't continue to deteriorate to fuel fears of the worst and global markets remain fixated on higher returns (increasingly from discounted assets), the Pound will likely start to turn its course. We look at the Pound under Brexit fears in today's Strategy Video.

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