A scenario that the markets, as well as bookmakers, found impossible just a few hours ago, became true. The Brits have decided to leave the European Union. This morning, the pound lost more than 10% against the dollar, and currently is at its 30-year minimum. The franc costs approximately 4.25 PLN, and the price of the euro is 4.50 PLN. How is it possible that everybody's vigilance has been put to sleep? What will happen with zloty? A comment from Marcin Lipka, Cinkciarz.pl analyst.
Friday, June 24th 2016, is most likely to become a day that investors will not forget for a long time. Today the news broke that the United Kingdom has decided to leave the European Union. This caused a panic reaction on the currency market, shares market, bonds market and raw materials market. The pound lost more than 10% against the dollar, and is currently at its lowest level in more than thirty years. The franc costs more than 4.20 PLN. On the other hand, we have a more than 6% overvalue of oil, as well as a 5% increase in gold.
The shares market situation does not look positive. Terminal contract for the American S&P 500 index is losing 5%. Last week the Morgan Stanley bank estimated the Brexit risk to be within the range of 40-45%. Currently, this institution claims that the European shares may lose 15-20%, and the GBP/USD pair may go to the area of 1.25-1.30.
However, it seems that the panic reaction on the market is not as big of a surprise, as the fact that investors, as well as bookmakers, have underestimated the risk of Brexit. This was despite that surveys were indicating a near draw for many days.
Bookies, market and “smart money” - a scenario of one gossip
Forecasting social events is an extremely difficult task. Especially considering that the results are very close. The British referendum was similar. For a long time the surveys continued to indicate a victory of the EU supporters. In mid-June more surveys began to be in favor of the Brexit supporters. Eventually, they came back to the initial trend of the EU support shortly prior to the referendum.
The Scottish referendum caused the market to expect a more secure choice from the Brits. Two years ago, the surveys indicated a 3-5% advantage for the supporters of staying within the United Kingdom. Eventually, this advantage was more than 10%.
Surveys were not the only factor that was creating opinions among investors. These opinions were determined by quotations of bookies as well. The less money they offered for the victory of the EU supporters, the stronger the pound was. This also had an impact on increasing value of the zloty, as well as the stock market shares. This caused that basically everybody focused on the bookmakers’ quotations instead of the surveys in the final phase of the campaign. These quotations were definitely in favor of staying within the EU.
Just yesterday, for each 100 pounds placed for Brexit, you could earn 600-800 pounds. This meant that the probability of Brexit was estimated for slightly more than 10%. Betting for the EU would get you only 8-10 pounds for each 100 pounds. However, these rates were not the result of the bookies confidence in the failure of Brexit. They were a result of the incoming bets that were definitely in favor of staying within the EU.
Moreover, a gossip has spread around the internet that the leading investment funds (colloquially referred to as smart money) have their own surveys that indicate a significant advantage for the EU supporters. This of course resulted in more money going to the bookmakers.
Eventually, we received a self-perpetuating scenario based on a gossip that yet again smart money know more than regular citizens, and yet again they will earn money on it. Rest of the market participants, as well as those who were placing bets, wanted to use this knowledge. This is the main reason for a significant surprise with the referendum result, as well as a clear underestimation of the risk that was visible in the surveys.
What will happen with zloty? Less investments, more expensive shopping, fuel and journeys
The morning zloty quotations show that the franc is above 4.20 level, the dollar is within the area of 4.12, and the euro is near the 4.50 level. However, there is a chance that these levels will be exceeded. The past few weeks have shown that the zloty was extremely sensitive to the risk of Brexit. Thus, now that the United Kingdom will leave the EU, the Polish currency is most likely to be one of the weakest currencies in the world, right behind the pound.
Estimating the maximum levels for the dollar, franc and euro is extremely difficult. The panic, as well as lower liquidity, may both cause sudden changes to be within the range of approximately 0.15-0.50 PLN. However, we took note of the Morgan Stanley (MS) estimations when analysing the Brexit consequences in our “Brexit: dangerous for Poland, fatal for zloty” article that was published a few days ago.
Morgan Stanley estimated the risk of Brexit to be quite high. Thus, it is possible that the market will begin to look closer at its forecasts now. The MS expected the euro to reach the 4.60 level, if the United Kingdom leaves the European Union. However, it is also worth noting that it expected the zloty to continue its weakening, which majority of other institutions did not do.
According to Morgan Stanley, in the case of Brexit the euro will be within the range of 4.60-4.65 PLN by the end of the year. Moreover, the MS economists were assuming in their report from June 16th that at that time the EUR/USD, as well as the EUR/CHF will decrease to 1.00-1.05 and 1.02-1.05, respectively. Calculations of the exchange rate of the franc, as well as the dollar will give us the range of 4.38-4.56 PLN and 4.38-4.65, respectively.
In conclusion, we may be dealing with a few-month long depreciation of the zloty exchange rate, as well as very sudden changes. They may also significantly exceed the estimations of the exchange rates above. There will also be a large uncertainty, not only in the financial markets, but in the real economy as well. Enterprises will begin to postpone their investments, consumers will postpone shopping, and a weaker exchange rate of the zloty will cause an increase in prices of imported goods. We will feel it the most by buying fuel, as well as by going on holidays abroad.