Britain’s vote to leave the European Union has “uncorked a genie” that is sending ripples through the currency markets and causing uncertainty to be the “new normal,” according to the latest research from currency analysts with Barclays.
In the bank’s latest Foreign Exchange Strategy note, Barclays argues that the huge uncertainty across the globe that has been triggered by the UK’s Brexit vote — the so-called “genie uncorked” — means that investors in the currency markets are in for a bumpy ride, and that what happens next is pretty much anyone’s guess.
Here is a crucial extract from Barclays’ research:
“The UK’s vote to leave the EU has ushered in what looks set to be a long phase of uncertainty. The implications of the vote are broad, with very direct economic and political fallout for the UK and Europe. They also signal the strength of anti-globalization movements more generally. The protracted leadership struggle in the UK and its associated uncertainty for the timing of the UK’s invocation of Article 50 (formally exiting the EU) only worsen the outlook. The effect on risk appetite and asset allocation decisions will likely be significant and long lived. As such, we take little solace from the recent short-term bounce in risky asset prices and currencies.”
And here is Barclays’ chart, noting how incredibly uncertain the outlook is for economic policy going forward (a view corroborated by Morgan Stanley in a recent note):
Understandably, given that it is obviously the currency most affected by Brexit, the pound has been the focus of huge attention in the markets since the Brexit vote. Sterling has slumped to a 31-year low against the dollar, and expectations are that it will keep falling.
On Wednesday, Goldman Sachs predicted that the pound could fall as low as $1.20, Deutsche Bank has predicted $1.15, while former PIMCO big dog Mohammed El-Erian thinks that parity with the dollar could beckon for sterling if Britain does not sort its EU membership out soon.
Barclays is slightly more optimistic in its outlook, saying that it expects an average price for sterling of around $1.28 against the dollar going forward, that is only a couple of cents below the current level, just below $1.30.
Barclays analysts Andres Martinez, and Juan Prada also argue that they do not see Sterling staying hugely depressed against the euro for the long term: “We expect GBP weakness against the EUR to last only one quarter as emphasis turns increasingly to the political stability of the rest of Europe.”
Events like the upcoming constitutional reform referendum in Italy, growing populism across the continent, and the continued uncertainty about Spain’s electoral situation, will contribute to those fears.
Away from the UK and Europe, Barclays is particularly worried about the currency outlook for emerging markets, pointing to a variety of factors — including weaker growth in China, a lack of firepower from central banks, and fears of a retreat from globalisation — will make emerging market currencies “the clear laggards” of the forex markets.
Here is the quote (emphasis ours):
“However, we believe markets are underestimating growth effects and the effects of financial contagion. Moreover, we are concerned that growth in China — to whom EM are more exposed — may disappoint in a stressed global environment amid a shortage of available monetary and fiscal policy tools. Furthermore, no set of economies is more at risk from a retreat from globalization by developed countries than EM; hence, to the extent politics in Europe and the US continue to fan worries about free trade, we think EM has potential to fall much further.”
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