trading

Brexit is once again grabbing all the headlines, as my colleague Fawad Razaqzada highlighted earlier today. The situation remains highly fluid, and with everything from an agreed-upon withdrawal bill to a change in government on the table within the next 24 hours, GBP traders may want to stay on the sidelines in the short term.

“The trend is your friend” is one of the first market witticisms most new traders learn, with good reason: After all, buying pullbacks or breakouts in established uptrends and downtrends is the essence of many of the world’s most successful trading strategies.

European stock markets have started Friday’s session brightly, extending their advance from the late afternoon rebound on Thursday. The rally has probably taken many people by surprise, although this shouldn’t be the case given that the markets in both the UK and US are still very close to their all-time highs. There is a reason why the markets are still elevated despite all the doom and gloom out there, and it continues to be this: cheap central bank money.

With the focus being almost entirely on the issue of Brexit and the pound this week – perhaps rightly so – traders should not lose sight of many other tradable opportunities that will present themselves in the interim. For example, the NZD/USD. The Kiwi has been climbing stealthily in recent weeks, due in part to a modest recovery in commodity prices. In addition, the RBNZ implicitly admitted at its June meeting that it is finding it increasingly difficult to loosen policy further when it once again warned of inflation in houses prices in Auckland being among its main financial stability concerns. Also boosting the NZD was last week’s release of Q1 GDP data, which came in surprisingly strong, at 0.7% q/q versus 0.5% expected and 0.9% in Q4.

Traders who have been selling the pound either in the hope or expectations of a British exit from the EU had probably enjoyed a good run of form in recent times. But the latecomers who sold the GBP/USD near major long-term support level of 1.40 were playing with fire, and when you play with fire you sometimes get burned. And unfortunately that’s probably what happened to some of these participants when the markets opened overnight with a huge gap in response to the latest opinion polls on the issue of Brexit, which showed that the two camps were running neck and neck at 44% each as Remain gained ground over Leave. The overnight gap then ballooned as some more of these bearish speculators were probably forced to exit their positions and the bulls entered the fray. Consequently, the GBP/USD has enjoyed its best one-day performance since December 2008.

Risk remained out of favour this morning as stocks tumbled and safe haven government bonds extended their rally, causing yields on the 10-year German bunds to drop below zero for the first time. In Britain, the equivalent yields have also fallen to a fresh record low level. This reflects the view that if Britain were to exit the EU, the Bank of England will have to either lower interest rates or introduce more QE to counter the economic consequences of Brexit. The probably that Brexit won’t happen has fallen to just 55% from around 64% on Monday, according to betting odds from Betfair.

So weak has the dollar been this week that even the GBP/USD has managed to regain its poise. Clearly, traders are no longer expecting the US Federal Reserve to embark on an aggressive tightening cycle after the central bank had hinted in December at several more interest rate rises when it increased rates for the first time since 2006. Since December, concerns have increased over the US economic outlook while worries over China have also intensified. Added to this, the stock markets have plunged, further diminishing the wealth effect phenomenon that the Fed had hoped would boost growth. The renewed selling pressure in the oil market has further weakened the outlook for inflation. So, there is less urgency for the Fed to raise interest rates again, especially given the fact that the European Central Bank has turned even more dovish and after the Bank of Japan cut rates into the negative. But this view could change somewhat if this week’s key US macro pointers exceed expectations by a meaningful margin. Today’s ADP private sector payrolls report and the employment component of the ISM Services PMI should provide a good indication for the official jobs data on Friday.