Forex Institutional Research: Credit Agricole FX Daily

Forex Institutional Research: Credit Agricole FX Daily

Key quotes from the Credit Agricole FX report: 

Brexit: how much is priced in?

After increasing in the past month, the implied probability of a Brexit in the market has stabilised or even receded slightly in the last few days. According to our estimates, markets are now pricing around a 55% probability of a Brexit, lower than the 60% implied probability reached at the end of last week but still higher than in February/March (~45%).

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The polls also indicate increasing support in favour of leaving since the beginning of March and a stabilisation in the last few days, but they have been less volatile so the ‘remain’ vote has retained a marginal lead over the ‘leave’ vote. In contrast, bookmakers’ odds on a Brexit have increased further in the past few days and are back to their historical highs reached in December and after the Brussels terrorist attacks, yet at a lower level than other measures (37%). According to the alternative measure we follow, based on big-data-filtered social media, the probability of a Brexit has decreased since it peaked at 58% at the end of March but it still remains slightly higher than 50%.

During the past month, a lot of different negative news has supported the leave campaign: the Brussels terrorist attacks, Cameron’s implication in the Panama Papers, the escalation of the refugee crisis, political tensions in the Eurozone… Developments in the past few days have been more supportive for the remain vote. The official campaign began last Friday, allowing the remain group to be more organised and audible and HM Treasury to present its long-awaited report, which estimates that a Brexit could cost the UK economy between 3.8% and 7.5% of GDP after 15 years. In addition, last week the IMF, the G20 and to a lesser extent the BoE Monetary Policy Committee all warned about the severe damage a Brexit could cause. Finally, tensions regarding Greece’s aid program and the migrant crisis have been less acute lately.

Our baseline scenario remains that the Brexit will ultimately be avoided, as we think the UK’s more favourable prospects within the EU and risk aversion should prevail when the time comes to vote. This force can be of particular importance given that 20% of the electorate is still undecided according to polls. However, a Brexit cannot be ruled out, as the recent supportive developments for the remain camp are unlikely to further increase the desire of the British populace to remain in the EU, while on the other side any negative event could dramatically raise the probability of a leave vote. We currently put it at close to 40%.

We estimate that the market-implied probability of a Brexit is now slightly higher than the probability implied by polls, bookmakers’ odds, social media as well as our house view. This doesn’t mean that investors really think a Brexit it the most probable outcome, as the market pricing includes risk premiums. That means that a lot is already priced in, as we think market pricing is likely to hover around the current level until the referendum. The potential for UK assets henceforth is therefore limited – on the downside as well as the upside – even if during the campaign the risks remain biased to the downside (financial volatility, political/social developments in the rest of the EU).

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