The broad risk rally has put Brexit fears to the side for now.
However, spike in 3 month volatility (closest duration to the EU in/out vote) indicates that investors are quietly taking protection. Recent polls on the outcome for the EU referendum remain too close to call, increasing the probability that the UK could leave the EU. The average result of six polls indicated that “remain in” votes captured 51% of the vote while “leave” captured 48% of the vote. This week, the BoE listed the risk of a Brexit at the top of near term threats to financial stability. Highlighting the expectations for the BoE to step in to control, Brexit generated volatility. Forward contact based on Sonia index are pricing in an interest rate cut by years end.
Last week soft UK economic data highlighted the weakness in sustained Brexit uncertainly. UK current account deficit reached an all-time high as foreigners cut purchases of gilts and reduced earnings from abroad by UK companies. The Brexit debate is highly centered on the UK huge current account deficit as tightening in lending from abroad (yet upwards revision to borrowing for the next three years) suggests that slack will be need to be picked up by domestic public sector.
With steady public sector deficit unlikely to normalize anytime soon, there is a risk that private sector investments will need to drop in order to fill in gap. With less participation by the household consumer, there should be considerable drag on growth near-term. Further reduction in capital inflows into the UK will weigh on the GBP. Elsewhere, March manufacturing PMI disappointed at 51.0 verse 51.2 exp.
The fall in sentiment confirms worries over the 23rd June EU referendum as businesses have increasingly become cautious in regards to spending and hiring decisions. We remain negative on the GBPUSD, watching for a continued reversal of bullish momentum targeting 1.4100.