Drifting from the EU: Brexit, Grexit, and How it All Affects FX

Grexit

Last year, the Greek Prime Minister Alexis Tsipras brought his people to a referendum to decide if Greece would remain in the European Union (EU). The EU has given Greece billions of Euros in soft debt to pay off the administration after Greece was hit hard by the financial crisis.

In 2012, Greece received a financial trim, where half of its debt was written off from European banks and governments, and yet Greece maintained their relaxed working conditions compared to the northern European nations – and the tax revenues didn´t match government expenditures. So, for the EU it was like throwing money into a black hole and, therefore, the EU forced new measures for Greece, and the Greek PM forwarded it to the people’s vote.

Actually, the referendum in itself was about whether Greeks would accept economic measures such as tax hikes, an increase of the retirement age etc., that the EU had imposed on Greece in order to dispatch the next round of cash. If the Greeks voted against the measures, then it meant that Greece would be booted out of the EU. It seemed a bit harsh but there was no other option.

As we now know, on July 5th, 2015 the Greeks voted to stay in the EU and accept the new restraints from the EU. Now, Greece is a small nation, and its economy only accounts for around 1% of the EU, so the Euro didn´t really mind the Grexit referendum.

Brexit

The situation with Brexit is another matter. Britain is a founding member and one of the four biggest economies within the EU. If the British people decide to leave the EU it might kick off a ‘domino effect’ for other EU members. We already know that the anti-EU forces in European countries are getting stronger, particularly after the mass migration wave which started in 2012-13 after the “Arab Spring”.

In Germany, Netherlands, Hungary etc., the extreme right wing parties are gaining more votes from the electorate, and in France, the National Front won the last local elections. A possible Brexit will motivate these teetering countries even more and give them a strong reason to present their cause to their citizens.

However, in the months leading to the referendum day, the polls showed that the remaining side of the campaign was slightly ahead, until last month. Logically, it felt right but the average Joe wasn’t sharing his opinion. I spoke to many British people before the referendum and it was surprising how many of them, particularly folks over 40, were in favor of Brexit.

The polls kept oscillating the entire month of June, and the odds of the remaining side winning the referendum were always much higher at the bookie. In the last few days, the polls showed that this side had a slight advantage. The murder of Labour Party member Jo Cox, who was a pro-EU campaigner a few days before the referendum, by an anti-EU extremist/disturbed soul, might have added a few points to the remaining side. But, the loud cheers of the leaving side during the BBC debate indicated that they might win as well.

The forex market was extremely volatile in the last couple of weeks before the Brexit referendum, particularly the GBP pairs and to a lesser degree the Euro pairs. The price action was messy, there was no clear direction and the moves were relatively big. You could easily get whipsawed, so we here at FXML, as well as most of the market participants, decided to stay clear of the GBP pairs in particular. Only on the last day, we decided to open a couple of long-term forex signals, which we will cover later.

The Brexit referendum day finally arrived on the 23rd of June, but there are no exit polls in Britain so we called it a day in the afternoon. As I woke up early the day after the referendum, I turned on the PC to look at the forex charts. The moment I saw GBP about 20 cents down and the Euro about 5 cents down – I realized it was game over. Voters above 45-50 years old were the ones to turn up at the voting booths in droves, and it was this age group that backed Brexit. While the age group below 40-45 were strongly against Brexit, their presence on voting day was dwarfed in comparison.

As we know, Britain has a new PM, Theresa May, an anti-Brexit campaigner. She has chosen Boris Johnson to be her foreign secretary and is preparing to push the ‘Article 50’ button to trigger the real exit.

The Pound Before the Referendum

The Brexit referendum was announced several years ago, but the Pound didn´t feel the pressure until it got close enough to really feel the impact. When this happened at the end of 2015, it tumbled about 20 cents until February 2016. That move was caused by the fear that Brexit would occur, and London would lose its role as a world financial center (which I don’t think will happen anyway, it’s status is not an attribute of EU membership). I know many think that New York is the world financial center, but half of FX is traded in London, which translates to about $2.5 trillion in everyday trades.

Anyway, this was the case and we had some very profitable long-term forex signals during this huge downward move. Then the polls started and everything became very chaotic. In that situation, it was better to stay out, because we couldn’t know what the next poll would predict. For this reason, we reduced our forex signals in the GBP pairs in the last weeks leading to the referendum and only opened sporadic short-term forex signals.

The Pound After the Referendum

As with most of the people, we thought that Britain would vote to remain in the EU, which would have had some positive impact on the GBP (at least in the short term). But, Brexit is a reality, so what happened after the vote in the short term? Also, what will happen in the mid and long term?

Short term – The short-term reaction was pretty short. It was over quickly, and only lasted a few hours – everything was over before the normal trader even realized what was going on. The British Pound fell about 18 cents in a matter of hours, delivering some massive several cent whipsaws on the way down. As we said, the short-term decline happened very fast. It set the exchange rate for the months/years to come between the GBP and other major currencies about 20 cents lower. The GBP devaluation shrank the size of the UK economy and now the UK is the sixth largest economy in the world with France taking over the fifth spot.

In the short term, GBP lost about 20 cents

Medium term – In the mid-term, there will be uncertainties. Obviously, the bottom side is the most vulnerable, as we saw in the first and the second week after the Brexit referendum. The 1.30 level was breached twice and the price fell as low as 1.28 in GBP/USD. However, the market remains clueless, no one knows for sure what´s going to happen politically or how the British economy will react. We´ve already had some indicators for July which show the leading sectors of the UK economy in contraction.

But, I think people/traders are taking this as the economy’s first reaction to post-Brexit shock and no one knows for sure. From what we have seen so far and from the analyses, we can say that the way Brexit will unfold politically and economically is uncertain, which leaves the GBP pairs without a clear direction. Obviously, the downside is more at risk, but whatever the direction you want to go, be careful because the whipsaws will be huge.

Long Term – The Scottish largely voted to stay in the UK and we don´t know how the Scottish will react. Some have called for another referendum to leave the UK, but we can´t predict the future. So, we have to remove the Scottish threat to Brexit. In this case, Brexit will happen gradually and some effects are bound to take shape.

Some weaknesses might even take their toll with time, such as the financial industry in London. It is the main sector of the UK economy which brings the biggest income, but with the UK out of the EU part of this industry might move to Frankfurt or spread across Europe. The French Prime Minister was trying to lure financial firms to move to France. It seems everyone will want a piece of the action from the large UK financial sector.

After all, Britain is out of the EU, which makes it a third party and the EU leaders have highlighted this before and after the referendum, so why should they be treated the same as a member state? If that was the case, why not Ukraine or (even worse) Russia? So, there will be hardship but we can´t calculate exactly how big the consequences will be for the UK economy. We´ve only had three pieces of economic data from the UK and cannot reach a definitive decision based only on that. But, these three pieces of data have been horrible, and if this continues for a few months then GBP/USD is heading for parity. Until then, let´s wait and see.

See our strategy article on Trading the News

The Euro after the referendum

Many were thinking that the Euro wouldn´t be affected by Brexit. After all, the UK was the one leaving the EU and the EU accounts for around 450 million people; the population of the UK is only 65 million. Still, there are other implications, such as the rise of the nationalistic parties in other European countries who now have added justification to their cause. This might spark a domino effect in the EU. We have already been hearing voices in France, the Netherlands, Hungary etc., and they will only get stronger now.

So this leaves Europe, as well as the UK, quite vulnerable. The Euro felt the heat at first and it declined about 500 pips the day after the Brexit referendum. Still, the 1.09 in EUR/USD couldn´t be breached and this pair had formed a base for more than a month in the 1.0900-1.0950 range. I guess this is all that the Euro will suffer from Brexit unless there´s a domino effect as we mentioned. If there will be a massive depreciation in the Euro it will likely come from the economic situation in the EU and from the actions of ECB (European Central Bank). The economy of the EU doesn´t seem to be affected by Brexit, unlike the UK economy, so that did and will affect the respective currencies in the months/years to come.

Brexit effect on the EU and the financial markets

The Brexit vote obviously had a negative impact on the UK stock exchange FTSE as well as on the other stock markets around the world. FTSE 250 lost about 15% of its value on Friday alone, while other indexes such as DAX, Nikkei, and NYSE lost between 5% and 10%. However, those losses have been recovered since then.

France´s Front National leader, who is a Euroskeptic and right-wing extremist, has warned of a Frexit (France out of the EU) referendum. The leadership in Hungary has long been in an open conflict with the EU and with close ties to Kremlin. Anti-EU voices are arising from other EU member countries such as Austria, Netherlands, Finland etc. The open door immigration policy by the EU and the economic crisis have been a heavy burden on the European people, so as distant and fictional as it seems, the dissolution of the EU is a possible scenario. After all, Brexit didn´t feel real until it really happened.

Our Performance

As we said in the Brexit section above, we weren´t very keen to trade the related pairs (CHF, Euro, and GBP pairs) during the Brexit referendum process, particularly the GBP. There was a lot of volatility in the GBP pairs in the months leading up to the referendum and, particularly, over the last month. All those polls shifted the winning odds from one side to another. So, we decided to stay away.

Only on the last day before the result, referendum day, we spotted a nice opportunity to trade. EUR/USD was close to 1.14 which is the lower line of the 1.14-1.15 resistance cluster. We decided to open a long-term sell forex signal in this forex pair right there for the following reasións:

1. This was a strong resistance area and the ECB doesn´t feel comfortable every time the price gets there, so the ECB members were expected to show up and slap the Euro down anytime with their comments.

2. Most of the market was widely expecting a remain vote, so if the Brexit side lost, everything was priced in because it would be no surprise. Any upside move would be a short-lived spike and the price would eventually move lower.

3. If the Brexit side would win, it would be a big surprise and the shock reaction would send the Euro down.

4. The price was right below the 100 moving average on the daily chart which had provided solid resistance before.

The 100 moving average was an additional reason for the sell forex signal in EUR/USD

As we now know, the underdog, the Brexit side, won, and that naturally came as a shock. The GBP pairs were about 20 cents lower when I turned on the screen in the morning and the Euro pairs were about 600 pips lower. So we received bad and good news from the forex charts; the bad news was that the UK voted to leave the EU and the good news was that we earned about 300 pips from our EUR/USD long term sell forex signal, which in reality closed in less than 24 hours.

That same day, we were closely observing the GBP/USD forex chart. The outcome of the referendum was clear, as well as the negative impact on the GBP. So, after the 20 cent decline, we were waiting for a retrace to follow. A 700 pips retrace did take place and we decided to open a sell forex signal near the 1.39 level. We were initially targeting a 200 pip take profit level, but that day was pretty emotional for all forex traders and we closed it manually for around 100 pips. If you are one of our forex signal service followers and kept the original take profit targets, then you should have made around 500 pips that day.

So, that was Brexit and all the accompanying events that occurred during that period. Although the volatility and uncertainty were high, we managed to control ourselves and closed those troubled days with a very hefty profit. Brexit is far from over; we don´t know how deep and quick it will be, we don´t know what will happen to the UK. The Scots, on the other hand, voted to remain and their reaction after the Brexit vote is unclear. We don´t know what will happen to the EU either. But, we will keep you updated and will try our best to make as many pips from the Brexit related events as possible.