European stocks to open higher on referendum day

Markets have been blindsided by Brexit. All other investment ideas have been put on hold while the referendum casts its long shadow over The City. As such, stocks have been moving in lockstep with the British pound.

Markets have been blindsided by Brexit. All other investment ideas have been put on hold while the referendum casts its long shadow over The City. As such, stocks have been moving in lockstep with the British pound.

European markets look set for a positive open on Thursday as Sterling made a new five-month high overnight after two polls showed a last-minute lead for “Remain.” The polls from ComeRes for the Daily Mail / ITV and YouGov for The Times” oppose earlier polls on Wednesday from Opinium and TNS, which showed narrow support for a “Leave” vote.

A late strengthening of the US dollar can partly be attributed to a nine-year high in US existing home sales and a drop in the price of crude oil  after weekly inventories saw a smaller draw than expected.

Even in the US, where the fundamental valuation of companies has almost no relationship to whether the UK is part of the European Union or not, stocks came off highs of the day on Wednesday, tracking a similar move in the British pound.

Despite mixed polls, European markets closed comfortably higher on Wednesday with the FTSE 100 gaining over half-a-percent. The confidence displayed in financial markets is at odds with the uncertainty portrayed by opinion polls. The move away from safe havens in favour of risky assets in the last few days means markets may be underestimating the fallout from a Brexit. 

At the moment there is a close correlation between betting odds and financial markets. Investment banks and hedge funds are using bookmaker’s odds and binary option spreads of the referendum result in their own risk models. Betting firms were a better predictor of the general election and seem to be driving market sentiment more than any other factor.

‘Remain’ is receiving the biggest amount of betting money, which has skewed the odds to suggest a 70-80% chance the UK will vote to stay. However ‘Leave’ is receiving many more bets. Markets appear to be taking the view that the big betting money is the smart money. An alternative viewpoint is that the referendum is a popular vote, so the number of betters should be a better guide of the outcome.

It makes most sense that the direction of travel in markets, in response to Brexit-related news, in the lead up to the vote, is how things transpire after the decision is made. News making a Brexit more likely, particularly polls favouring leaving has caused selling in the British pound and a rush into haven assets like gold and government bonds. News favouring Britain staying has done the opposite.

The same markets are still affected by the Federal Reserve’s decision to keep interest rates low. Low interest rates are typically positive for gold and drive bond yields lower. If Britain votes to remain, any resulting fall in gold and rise in yields may not last long because of the dovish Fed. The scenario is slightly different for the British pound. If the Fed remains on hold and the Bank of England no longer has Brexit to prevent a rate hike, that would add to the positive outlook for the British pound, were Britain to remain in the EU.

Even if betting and financial markets are proven correct and the UK votes against Brexit, the potential for political fallout in the aftermath is a downside risk. Not all Bremain outcomes will be created equal. Should the referendum result come down to the wire, like 51:49 or even 52:48; that could call time on David Cameron’s career as UK Prime Minister. Were results more favourable, say over 55:45, Mr Cameron would be vindicated but likely ostracised by the EU sceptics in the Conservative Party.

EURUSD – The euro is still directionless, closing Wednesday at 1.13, the middle of its 1.11-1.15 range that has been in place for three months.

GBPUSD – A tweezer top at 1.4770; the pound’s 2016 peak and the top of its 1.40-4.47 trading range was a bearish signal so the break above is strongly bullish. A change in momentum on the weekly chart supports an upside break.

EURGBP – The euro Sterling pair has pound support at 0.7650, where there was a sharp reversal higher on March 10. The pair remains range bound and a bounce before 0.76 appears likely.

USDJPY – Dollar yen has been stuck in a 100 pip range for three days within its long term downtrend. A close above 105 would suggest a more substantial rebound towards 106.50, near the June 6 low.

Equity market calls

FTSE100: to open 42 points higher at 6,303

DAX: to open 48 points higher at 10,119

CAC40: to open 16 points higher at 4,396

 

 

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