WIDER WORRY - It's pretty clear the market is starting to really get worried about a potential UK exit from the EU. Up until this past Friday, the risk and worry associated with the event seemed to be well contained to the UK, and even then, the market was much more confident the remain camp would come out on top. But now with the leavers gaining ground and pulling ahead in the polls, the world is paying closer attention as the June23rd referendum draws near. And so, we are seeing a mass liquidation of risk correlated markets, with more than the Pound under pressure.
BIG DEAL? - What's the big deal? Well, if the UK votes to leave the EU, not only does it introduce an extended period of uncertainty that could last more than 2 years, but it also undermines the legitimacy of the European Union and likely inspires second thoughts amongst other countries currently in the union. But the EU knows this well and will therefore make it exceptionally difficult when the UK tries to renegotiate new terms after exit. So all of this translates into a big, drawn out mess in a major part of the world.
BIGGER DEAL? - What's the bigger deal? The bigger deal here is that there aren't any tools to help offset any potential fallout from a potential crisis that an EU exit would cause. In year's past, no problem. We get a crisis and central banks respond with accommodative monetary policy. But that option is no longer on the table, with all of the central bank ammunition used up battling the financial crisis of 2008. And so now you have the potential for a real sh*%t storm, that poses major systemic risk to the global economy.
STRATEGY - How am I trading all of this? I am short the SPX500 from 2115 and will be looking for a drop back towards 2020 in the sessions ahead. Otherwise, I have some exposure long AUDNZD, which doesn't correlate as directly to all of this. I will be looking to buy extreme setbacks in USDJPY, as even though the market is dropping on traditional correlations with flight to safety, ultimately, a strong Yen is not in the best interests of the Japanese economy and the Japanese currency is NOT a safe haven currency.
WHITE BLOOD CELLS - There is one more trade out there I like which is actually buying the Pound. While I have outlined the risks associated with an EU exit and why the potential for exit is rattling markets right now, the key takeaway here is not the Brexit risk but the fact that any unforeseen risk or shock to the global market will continue to pose serious risk to the health of the global economy, with central bank policy exhausted. Think of central bank policy as your immune system and think of the 2008 crisis as a virus that your immune system has been battling. Well now, your immune system is exhausted, broken down and exposed to any other simple virus that comes along.
BUYING THE DIP - So I don't believe it will be the EU referendum that will really rattle global markets, as I believe the remain vote will still come out on top. My bet is that the Bank of England will deliver an intense upgraded warning on Thursday over the risks associated with an exit. Remember, the Bank of England is not bound by the purdah period. This warning will probably do enough of the trick of scaring the many undecided voters back over to the remain side. If I'm right, there should be limited GBP downside from current levels, with plenty of upside potential ahead. So I will be looking for another opportunity to buy GBPUSD into this dip.