I confess to having read little of the research (sell-side and buy-side research is not routinely made publicly available) and done none of it on my own because (1) I'm not paid to do such things anymore, natch; and (2) I don't have easy access to Bloomberg.
That being said, this is perhaps the most exciting (re: potentially volatile) event to drive the markets since the summer of 2013. That was when the Fed convinced the markets that it was going to begin tapering its large scale asset purchase program, and then head-faked at the last moment, resulting in the now infamous "taper tantrum."
Luckily there are some excellent analysts in the financial community, and many trading ideas are developed in a fairly straightforward way. Most of what I am about to suggest has no doubt already been analyzed and published, and they will have used this style of analysis to develop concrete trade ideas. If you have access to such research, or are sitting in front of a Bloomberg looking for inspiration and how to evaluate what trades may have some momentum, this is what I would recommend screening for, and why:
1. Evaluate correlations between currencies - primarily the GBP, EUR, USD, CHF (duh), but I am sure currency strategists have checked all of them - and see if those correlations have changed significantly. In particular, consider time periods prior to and after February 20th 2016, which is when Prime Minister Cameron announced the June 23rd date for the UK referendum on leaving the EU.
For example, the biggest recent drop in the GBP/USD rate was on the day of the announcement (2/20/2016). The GBP/USD actually hit its lowest level in at least 5 years (that's as much history as I can see - it was probably much longer than that) but rebounded. It is now trading above where it was prior to the announcement of the referendum, spiking higher in the last two days as some polls indicated a momentum shift towards staying in the EU.
2. Evaluate correlations between currencies and stock indices. Same as above - look for correlations that have gotten stronger (or reversed in sign) prior to the referendum announcement and until now. Returns from trading currencies historically are not strongly correlated to other asset classes. And by "not strongly correlated" I actually mean they used to be barely correlated. That's one of the reasons why hedge funds and other asset managers / investors began trading currencies as an asset class - because their performance is not historically correlated. If there is evidence that has recently changed (and again, I'm sure plenty of analysts have been evaluating this for months now) then there is momentum that can be captured depending on how the vote turns out. Either investors will be unwinding or some will double down. Timing is a bitch though. I can't help you there. Talk to currency traders and cross asset strategists. They will no doubt have published research analyzing all of these factors by now.
3. Forget trying to analyze "fundamental value" of currencies (whether its the EU or GBP or anything else). Trade on volatility and momentum. I will add a link tomorrow to an outstanding paper by (if I remember correctly) some analysts from Merrill Lynch who did deep dive research on currency trading and performance of those strategies. The upshot is that although economists will argue that currencies should maintain purchasing power parity, or interest rate parity, its rarely true and those strategies produce reasonable returns only if one currency gets very badly away from "fair value" - which typically means the country is experiencing hyper inflation. Ignore that stuff. When trading on vol and momentum, trust your quants. (I know, talking my own book.)
Technical note on correlations: You can do these historical correlations on your Bloomberg in a matter of minutes, looking at the time periods before and after the referendum announcement. There is a menu option for looking at the level of the index (be it a stock index, CDS index, bond yield or funding rate) against a currency pair, or the change on the day of the index vs. the currency. For this purpose you want to monitor the correlation of the levels. Don't worry about the changes in prices or yields on the day. That's typically only relevant if you or other traders are using one instrument to hedge the changes in price versus the other. If there is an exogenous factor (like a Brexit vote) driving changes in two financial indicators or instruments, it is only the levels that matter when evaluating potential moves - not how correlated price changes are on a day to day basis. (That being said, seriously, don't try to hedge one financial instrument using another unless the correlation of changes on the day is quite robust.)
4. Rampant speculation on timing. The above correlation analysis and research from strategists that see the flows can guide you to the kinds of trades that investors have entered ahead of the vote. Obviously what is important now is - depending on how the vote goes - when will those trades be exited and produce momentum in the other direction? What we know is that the UK and EU have both promised (threatened, really) that if the UK does vote to exit, that process will start immediately. Like, France would probably throw stink bombs in the chunnel. In reality the UK will need to pass legislation to complete the exit, which could take 6 months to 10 years (this is not an exact science). The markets wont care. The exit momentum will be priced in quickly. Investors who are long the currency, the stocks, the bonds, etc may have some breathing room to unwind or lower their allocations in a reasonable fashion, since many if not most of those trades will be positive carry and allow some cushion. Some may even choose to try and wait for the initial "panic stations" reaction to pass and hope for a cooler heads will prevail (a chicken little) bounce back.
On the other side, if the vote is "stay" then all the shorts may need to unwind fast. Rush for the exits. Depends on what level they entered the trades. But short trades are typically negative carry, and once it definitely moves against you, investors may want to exit quickly. Though evidence from the rise in the GBP/USD could indicate that many have already hedged their bets. Or put on new ones. Tough to say. Ask your traders and your strategists. They will know better than myself.
Timeline for tomorrow:
- According to a BBC article, The UK's EU Referendum: All you need to know, the UK polls close at 10:00pm (that's 5:00pm NYC time) Thursday, June 23rd. The (paper ballot) votes will be collected at regional centers and counted.
- Expectations are that there should be a pretty clear indication of which way the Brexit vote is going by 04:00am Friday, June 24th (11:00pm NYC time, Thursday June 23rd).
So traders are bringing in changes of clothes, guzzling coffee and showering at the gym for the next 48 hours? Wow, that must be so tough.
- Don't kid yourself. Traders are adrenaline junkies. They live for this kind of volatility. These are not people who fret about "work life balance". They eat, sleep and breathe their P&L.
You sound jealous.
- I am. This is when the markets and the jobs of people in finance are at their most interesting. It's unpredictable and can be nerve wracking, there is a terrific sense of urgency (hair on fire) and a crucible of learning, all at the same time. The gym at Bear Stearns used to be packed at 5:30am every day a big economic number was coming out or market-moving event was occurring. And I always ended up running on the treadmill next to the damn swap traders, who would reach over and try to increase the incline when you weren't looking.
Fasten your seat belts. Best of luck to everyone in the markets.
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