Currency traders’ many unbearable waits

The ticking of the clock ahead of the June 23rd UK referendum on EU membership has become a deafening drumbeat after a recent spate of polls seem to show a drift in favour of EU rejection, most dramatically in the 10 point margin of the Leave over Remain responses in Friday’s ORB poll results. The market for trading the sterling exchange rate has become dysfunctional ahead of this event, with liquidity virtually non-existent in the options market for options with expiry dates on the other side of the vote. Implied options volatility for what little volume is trading has spiked to levels not even seen at the height of the global financial crisis.

 And beyond currencies, the latest aggravation of Brexit fears is not only making waves in foreign exchange and UK domestic asset markets, but has also generated a widening contagion effect across global asset markets after that Friday poll. It’s impossible to tell what might unfold around a Brexit scenario, but volatility will inevitably settle very quickly as the market adjusts to the new reality, with the Bank of England and perhaps even the ECB offering a helping hand if markets go haywire. The longer run issues for sterling remain regardless, notably the world’s worst structural deficit for a developed country at worse than 5% of GDP, so even a relief rally in sterling in the event of a remain could prove short-lived. That will be particularly true if the recent weak US data points to a US recession dead ahead. A US recession would inevitably mean weak asset markets and weak asset markets punish current account sinners as investors bring their funds home, leaving deficit nations lacking funding.

 That brings us to the next and even bigger unbearable wait, one that will immediately beset markets as soon as heaving and convulsing over the UK referendum has settled: the four and a half month wait for the November 8 US presidential election. As long as polls point to even the possibility of a Donald J. Trump presidency, global markets will remain in unbearable wait mode. Why? A Clinton presidency merely extends the status quo gridlock of the Obama years. But a Trump presidency? His volatile and controversial personality aside, Trump is something entirely new. With a Congressional majority, Trump would be the first president since Reagan to seize the policy center stage from a Federal Reserve that long ago over-reached and lost its credibility.

 And there are other unbearable waits as well that may continue to stymie any attempt at durable trending moves in exchange rates until at least the other side of the US presidential election. When will China allow is currency to recognize reality? What will a possible Brexit vote mean for Europe and the next major European elections? And shorter term, where is the pain point in the Japanese yen strength that triggers the next big move from the Bank of Japan and/or Abe government? There is wide agreement that BoJ will gain nothing from expanding the existing QE program and that only some combined fiscal/BoJ forcing of the economy can see Japan’s GDP rise in nominal terms.

 The only trend that may be evident through all of this is that central banks’ policy moves will continue to founder as they lose sway over the market. So the question after nearly ten years of futile central bank policy making only bring unbearable uncertainty amidst the unbearable waits as the question remains: What next?

The author is Head of FX Strategy, Saxo Bank