This is the situation we face with the current “Brexit” scenario (which start Thursday, outcomeFriday) with two very different scenarios being forecasted for the two possible outcomes. The first possible outcome is that Britain remains in the European Union (EU).
This has mostly been the favoured outcome but in recent weeks, the certainty of a “Remain” vote started to wane. Sentiment shifted back to “Remain” last week when British MP, Jo Cox, was murdered by a pro-Brexit campaigner. Should Britain stay in the EU the outcome will be pretty simple, much of the status quo will still hold in the UK and World economy, the Pound will strengthen and much of the “risk-off” sentiment will dissipate which will bode well for the Rand and other risky assets.
The other scenario would be for Britain to leave the EU, which will lead to much panic in the market much like the emergency situation detailed above. The exact fallout of such a vote cannot be estimated, but some things seem more likely than others. So what happens to economies when it experiences a shock?
- “Brexit” could stall the UK economy, as long forged trade agreements will have to be renegotiated, which will impact production and ultimately growth. In a current climate of low World growth, placing yourself behind the eight-ball can only do more harm than good.
- Should the economy falter, it will lead to mass unemployment and the overall well-being of Britons. With interest rates already low there will be no measure that the BoE can take to help the UK economy and its people cushion the blow of a hard landing.
- The current economic state of Britain is one where they are running twin deficits (current account and fiscal deficits, should they leave the EU, they will have to face these economic problems alone as an island state, which they will be. Out of South African economics 101, we have learned that the only way to fund deficits is by currency devaluation or foreign investment. Should Britain leave the EU, the sentiment regarding Britain will change dramatically which will lead to investors running for the exit in an event to pull their funds out of Britain. That leaves currency devaluation as the only viable option left.
The sensitivity the market has to “Brexit” can be seen in the way markets reacted on Thursday last week when the Rand ran up to R15.50, from rumours that the “Exit” side has gained the upper hand.
This was merely in response to market uncertainty as risky assets certainly, as the Rand, do not like uncertainty. The Rand clawed back all of its losses after sentiment shifted following the murder of Jo Cox. That sentiment continued on Monday as the Rand broke back below R15.00 and closed the day in the mid R14.80s.
It is important to note the impact of the “Brexit” vote, as last week saw the Fed also making their announcement regarding the US interest rate.
As expected, Fed chair Janet Yellen kicked the can further down the road by stating there will probably be only one hike this year and delayed the hikes going further forward. Normally this would have meant the US dollar losing ground and EM currencies picking up ground. Nothing happened, the market saw it as a non-event as all eyes focus on the “Brexit” narrative.
That is the expectation for the week as well with markets swinging wildly on every bit of news coming from the “Brexit” narrative and largely ignoring Yellen’s testimony to Congress tonight (Tuesday) unless something dramatically had changed from Wednesday last week.
The formula is simple this week, if the indications are that Britain is going stay in the EU, it will be Rand positive and vice versa. The adage with EM’s will hold true this week; negative news outweighs positive news, and the Rand will depreciate a lot more than it will appreciate on the back of the relevant result.
On the South African side, our inflation number will be released on Wednesday. The release will be a key number to see how far above the inflation targeting band actual inflation is at the moment and what the likelihood of a further rate hike will be when the MPC convenes again in July.
On Friday, the print for the trade balance will also be released and with positive numbers on the last few occasions, we expect the trend to continue. The trade balance has lost some of its market-moving verve, and only a hugely negative number will have an observable market effect.
This week promises to be a wild one with massive volatility being expected and thus a one Rand range for the Rand will probably err on the side of caution. Importers should look at opportunities to start hedging at these levels.
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