Sourced from abceconomics.com
Following concerns of a possible U.K. exit from the European Union, the British pound has dropped to its lowest level in close to seven years before recovering slightly. Fears of what has become known, slightly unoriginally we feel, as the Brexit, have recently heightened following a lukewarm response from politicians to the deal British Prime Minister David Cameron made with the European Union.
The influence of Mayor of London Boris Johnson is worrying for Cameron.
Hopes were raised last week when Prime Minister Cameron secured a deal with the leaders of the 27 member nations which was being hailed as a victory for the U.K. form the Cameron camp. But since then there has been an increase in campaigning for an exit from high profile people such as the Mayor of London Boris Johnson.
The always charismatic Boris Johnson is quite an influential person in the U.K. and by throwing his hat into the ring, we are much less certain about the result then we were last week. We still believe the vote will go in favor of staying in the European Union, but it is admittedly going to be reasonably close.
Because there are concerns that the British pound would weaken should the U.K. exit the European Union, the market appears to have priced in the uncertainty by dragging the currency down by 4 percent this year. As things stand now we feel it has found its level, but will most probably sway up and down depending on how the referendum is poised.
We see a long trading opportunity with the British Pound.
As we said previously, at this stage we feel the probability of the U.K. staying in the European Union is higher than an exit. For this reason, we see a trading opportunity in going long with the British pound in the run up to the June referendum. Equally, those which feel an exit is the more likely scenario, could find a great shorting opportunity here.
We expect the media to portray things as being too close to call which could cause fluctuation in the pair. After all, sensationalistic headlines do appear to sell more papers than the truth. But much like the vote for Scotland to stay as part of the U.K., which was called too close to call, it didn't really end that way with a reasonably strong victory for the U.K.
We worry the U.K. would suffer economically from a Brexit.
Come June we could be proven incredibly wrong, but we just don't see the Brexit occurring. Or rather, we just don't think the Brexit should occur and therefore expect the U.K. to vote against it. While nobody has ever left the European Union, so everything is speculation, we worry about the repercussions of leaving. Perhaps the biggest advantage of the European Union is its free trade agreement between member nations. Should the U.K. exit it would lose this privilege, and while it would then be free to establish trade agreements with non-European Union nations, it could risk losing some of it negotiation power internationally. We also have concerns that the City of London's role as the financial capital of Europe could come under threat should they leave. At present it is seen as the gateway into Europe from large financial institutions from the United States and China. We feel if the gates shut to Europe for these financial institutions, so could many companies in the U.K. This could potentially cause an economic slowdown in the U.K. Of course, there could be many positives that do eventuate from a Brexit, but as no country has yet done this, there are just too many unknowns as far as we are concerned.
Interest rates add a layer of complexity.
The United States and the United Kingdom are expected to increase and decrease interest rates, respectively, this year. Although just when this will happen, is a topic for mass debate, it is becoming evermore unlikely that these decisions will occur before the referendum in June. The possibility of each respective central bank raising before then, however, does add a layer of complexity to any trading. We are expecting a bounce of around 4 percent should the U.K. stay in the European Union, which is why we feel this is a great long trade. But any interest rate decisions from either side of the Atlantic could scupper these gains.
GBP vs USD: Sourced from Dailyfx.com
As you can see above, we have targeted the 1.468 mark, which is approximately 4 percent from the current trading price of 1.411. This could come much sooner than June, and it could of course drop further before then, but we feel ultimately this is where it will end up once the Brexit is dismissed. To trade this we use futures contracts, but you can use ETFs to do the same also. The CurrencyShares British Pound Sterling Trust ETF (NYSEARCA:FXB) tracks the pound versus the U.S. dollar and a basket of currencies, and the iPath GBP/USD Exchange Rate ETN (NYSEARCA:GBB) tracks it purely against the U.S. dollar.
Best of luck with your trades!
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: We are long GBP futures versus the U.S. dollar