What if the markets got it wrong?

Sterling is trading at highest level in 2016 above 1.48 against the US dollar, when it’s supposed to be at brink of a collapse due to the possibility that Britons may decide to exit the EU. This seems to be contradictory for many traders sitting on the sidelines watching the polls, and probably asking what’s going on here. 

Although most recent polls swayed toward the remain camp in the last couple of days, the lead is still very narrow, which doesn’t explain the surge in pound. However, the markets are being completely reliant on the predictions from the bookies, which strongly expect “remain” to win the referendum. If history is any indication, the bookmakers will get it right. They got it right on the general election last year, and on the Scottish referendum in September 2014, which made them a more reliable source than the polls.

Looking deeper into the bookmakers’ odds, 70 – 80% of the money placed is in favor of a remain vote, but in-terms of the number of bets, more than two third are going for a Brexit. This makes the outlook even more complicated and supports the assumption that votes can go either way.

Not only did the sterling rally this week, but broad based risk appetite also boosted high yielding currencies, equities, and AAA sovereign bond yields, as if investors are saying we are almost convinced the UK will not divorce the European Union. Risk premium is barely priced into financial markets suggesting that the upside is limited from current levels, but if markets have got it wrong here’s the interesting part.

A Brexit vote is likely to be disastrous. Many analysts were trying to predict the magnitude of Sterling’s fall in case of a Brexit, whether it’s 10%, 20% or more than 30%, all agree it’s going to be severe. In the equity markets, the banking sector will be hit the hardest, and will likely to see a double digit drop in UK’s major banks.

For the next 24 hours, liquidity most likely to dry and big swings to be realized in all asset classes, but the real action to start after midnight on Thursday when individual regions start to declare their vote counts, ahead of the final results early on Friday morning.

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