Brexit Is A Reminder That Volatility Is Here For The Long Run

  • Political considerations trump rationality
  • A general election could yield another surprise
  • The politics in the US are similar
  • Volatility comes from surprises
  • Trading is the optimal approach to markets, and that will continue

Brexit has been an issue in the headlines for over three and one-half years. The UK’s membership in the European Union has always been half-hearted. At the turn of the century, when the member nations abandoned their respective currencies for the euro, the UK did not give up the pound. They always kept one foot in the EU and one foot outside the union in a sign that more than the English Channel separated the UK from its neighbors on the European continent. 

The Brexit issue has impacted markets across all asset classes at times, and commodities and the foreign exchange markets are no exception. 

The ongoing saga continues to be one of the factors that have caused uncertainty about the trend towards globalism. Over the past week, we were reminded that Brexit continues to be a politically charged issue that will dominate the news cycle for the coming months. Three UK Prime Ministers have dealt with Brexit since the June 2016 referendum. David Cameron, who favored remaining within the union, resigned after the initial vote in 2016. Theresa May spent her time at the head of the government negotiating successfully with the EU on proposals for an agreement for the divorce but met with failure when it came to approval from her Parliament. Earlier this year, Prime Minister Boris Johnson pledged to guide the UK out of the EU by the October 31 deadline with or without a deal with the EU and approval from the Parliament. After political wrangling, Prime Minister Johnson came up with a proposal on the Irish border, which was a significant sticking point. A dual customs zone solution paved the way for an agreement. Last week, the legislature handed the new Prime Minister a defeat that will prevent him from keeping his promise. The Parliament voted in favor of the deal. However, it voted against a final divorce agreement because of a timing issue. Brexit is now a political saga that has little to do with fulfilling the will of the British people. The divorce has more to do with the future political leadership of the UK. 

The latest events surrounding Brexit are a reminder that volatility in markets will continue as the UK is now set up for a do-over vote on the divorce from the EU. Volatility in the British pound currency will continue.

Political considerations trump rationality

It is beyond comprehension that after more than three- and one-half years and more than a handful of proposals that members of the Parliament need more time. The Irish border was the previous excuse for sending the Prime Minister back to Europe with her tail between her legs. When it comes to the current Prime Minister, more time turns out to be political fodder in the next election. For a politician, nothing is worse than failure to keep a promise. More time translates to a roadblock to Boris Johnson’s pledge. 

Keeping the Tory Party in the leadership seat turned out to be a political strategy. The Labour, Liberal, and other political parties in the UK wanted nothing more for the Tories to fail. At times, the power to criticize leadership is more useful than the leadership role. 

In a sign that the UK voters are more than fed up with their representatives, the most recent election for delegates to the European Parliament yielded a surprise. The leader of the movement to divorce from the EU was a member of the EU Parliament. Nigel Farage is an outspoken businessman turned politician. In six weeks, he set up the Brexit Party, which thumped the Tories, Labour, and all other parties in the EU election. Farage offered an olive branch to Prime Minister Johnson with two caveats. His offer to throw his political weight behind the Prime Minister came with strings. He insisted that Johnson purge the Tories of any MP that did not support a hard Brexit. 

Moreover, he insisted that the UK exit without an agreement. Farage does not want to pay one shilling to the EU as a price for the exit. While the offer was likely tempting for the Prime Minister, Mr. Farage is not popular at all with the sitting members of the Parliament from any political party. 

The UK Parliament may have made a tragic mistake not accepting the deal, as the potential for an exit with no agreement is now back on the table. 

A general election could yield another surprise

On October 24, the Prime Minister backed down to the Parliament. After the legislature blocked his plans for a hard Brexit by passing a law that without a deal and the Parliaments acceptance, he would need to request another extension until at least the end of January 2020. Late last week, Johnson told his Parliament if they back a general election on December 12, they could have more time to scrutinize his Brexit deal. 

The general election will stand as a proxy for a second referendum. The Prime Minister is leading by around 15% in the polls. He believes that a victory will be a validation of both his leadership and the Brexit deal that is currently on the table.  However, some leaders among the MPs could stand against a snap election when it comes up for a vote on Monday, October 28, saying it is not in the national interest. It appears that the opposition parties want to wait and further weaken the Prime Minister, so he limps into the election. He will already face voters after failing to fulfill his promise and the will of the people in the 2016 referendum. If he cannot even push through a general election on December 12, voters may look elsewhere for leadership, which would open the door for a surprise. 

The Labour Party leader Jeremy Corbyn wants desperately to lead the nation, but he is less than popular. A splintered electorate could open the door for Nigel Farage to pull another rabbit out of his political hat with his Brexit Party after his dismissal by the Tories. 

The bottom line is that the Brexit saga in the UK has little to do with the divorce from Europe and everything to do with which party and leader will have power over the coming months. The will of the people has become a secondary issue. The opposition to an election seems to be a ploy to buy more time to weaken Mr. Johnson. After voting in favor of Brexit in June 2016, some representatives do not trust the voters without manipulating the system for the desired outcome. 

The politics in the US are similar

On the other side of the Atlantic Ocean, the United States is in the midst of a political storm. The majority of the House of Representatives are Democrats after the 2018 mid-term election. Many Democrats favored impeaching President Donald Trump on inauguration day in early 2017. After the Mueller report on Russian influence in the 2016 election did not provide the smoking gun to remove the President from office, the opposition did not give up. Now, allegations that the President held aid to Ukraine hostage for political dirt on former Vice President Joe Biden have resulted in a full-fledged impeachment inquiry. It appears that an impeachment vote by the House will lead to a trial in the Senate. Just like in the UK, the opposition party is looking to weaken the incumbent President, so he limps into the 2020 election after being impeached. The Democrats in the house do not appear to trust the American voters who will go to the polls next November. 

While the issues on both sides of the Atlantic are different, the political strategy appears to be the same. Politicians looking for control and power have put all other matters to the side and have focused on political aspirations. In democracies and republics, representatives fulfill the will of the people. In the UK, the MPs have ignored the 2016 referendum. In the US, the majority in the House of Representatives have interpreted their election as a mandate to undo the 2016 Presidential election. 

Volatility comes from surprises

The most extreme periods of volatility in markets across all asset classes come surprises. The shock of the June 2016 Brexit referendum sent gold to a high at $1377.50 per ounce. At the same time, it sent the value of the pound versus the dollar from $1.50 to $1.20. 

Gold is a barometer for fear and uncertainty in markets across all asset classes. Gold’s unique position as a hybrid between a currency and a commodity has caused the price to break to the upside in all currencies around the world. 

Source: CQG

The quarterly chart shows that the yellow metal broke above the top end of a $331.30 trading range that had been in place since 2013 in June. The price action that took the price to over the post-Brexit high, which was the critical level of technical resistance, is a sign that the geopolitical and economic landscapes are problematic. 

Source: CQG

Gold in British pound terms recently rose to a new record high as it did in euros, yen, rubles, yuan, Australian and Canadian dollar, and most other currencies. While the yellow metal has not yet appreciated to a new record level in the US dollar and Swiss francs, the trend in both currencies remains higher. 

Gold is telling us that there are more surprises in store over the coming weeks and months. In the UK, the election for the next Prime Minister could yield a surprise. We have learned never to take an election result for granted. The Brexit referendum was supposed to fail. In the US, President Trump looks like a political lame duck, but he trailed far behind in the polls up to election day in 2016. At the same time, the progressive agenda offered by Democrats could change the political system in the US from capitalism to “Democratic Socialism.” The impact on the US and world could be dramatic. Under President Trump, the US became the world’s leading producer of energy in the form of crude oil and natural gas. The current frontrunner in the polls on the other side of the political aisle is Senator Elizabeth Warren. She pledged to end fracking on day-one of her administration. An end to fracking would change the dynamic in the global energy markets dramatically overnight. 

The trade war between the US and China, a provocative Iran in the Middle East, Brexit, political divisiveness in the US, and the many other issues facing the world these days promises to provide more than a few surprises. 

Trading is the optimal approach to markets, and that will continue

Volatile markets are a nightmare for investors. At the same time, increased price variance across all asset classes creates a paradise for nimble traders with their fingers on the pulse of markets. The stock market made marginally higher highs since late 2018, but it has experienced periods of extreme price volatility. Buying dips and selling rallies has been the optimal approach to the equity arena. The same goes for many other markets, and the potential for surprises will continue the trend. 

Approach markets with a plan. Make sure that the rewards you seek are commensurate with the risks taken. Always remember that a risk position is long or short at the current market price, not at the original execution level. And, continuously re-evaluate the reason for a risk position. In volatile markets, the fundamental and technical factors that prompt a trade or investment change often. 

Market volatility is a function of political and economic events when it comes to the macro environment. Brexit is an issue that should remind us that price variance will continue as logical solutions are a path that is never a guaranty.