Red Alert - BREXIT notes ( part 2 ) - Forex liquidity problems

Liquidity

As we a will be approaching the close of polling stations (2100 GMT) tonight, the liquidity will be likely drying up more and more, thus the risk of gapping or abrupt market moves will become very high. Being prudent in such cases means to scale down the trading activity, ticket sizes or eventually, open a bottle of good wine and watch the market.

As the whole FX industry is changing, there is more and more algos and machines running the trading instead of human prop traders these days. That may also have a negative effect on market making and supporting the sufficient liquidity, as machines are easy to turn off anytime, especially in the event of huge market risk/stress. It is good not to forget about that.

In case of Leave vote the BoE is ready to cut the rate by 25 bps and eventually, look at reinstating of asset purchases. Globally, the central banks are ready to support the market by additional liquidity and to calm down everyone, G7 is preparing a statement. Not only ECB can cut the rates but also other central banks in Europe can do so, as an immediate reaction. Definitely they will monitoring their currencies strengthening and inflation weakening. And as Yellen and other Fed officials mentioned recently, the next rate hike can be postponed to Dec or next year, as they do not feel comfortable with Brexit referendum as such, as well as its impact across the markets.

What’s next after Leave vote?

Well, hard to say, but there are two scenarios on the table:

1) David Cameron would need to activate the Article 50 of EU Treaty and start the negotiations with Brussel and member states about conditions of exiting the EU. They will have a two year period to reach the agreement and if not, the applicability of EU Treaties over UK will cease to exist. If no agreement is reached, the UK will become a country without any agreement in place with EU.

2) The negotiations with EU will start first and then, the Article 50 will be activated just to complete the process. Under both scenarios, it would be extremely difficult for UK to negotiate advantageous conditions of further relationship with EU.

We don’t want to speculate on the outcome at the moment, but there is lots at stake and it would very costly for UK and EU to walk that way. Also worth of mentioning, if UK decides to join the club again in the future, it would be pretty hard to get the consent from every member of EU.