Brexit: it ain’t over until the fat lady sings
At the end of last week, it looked like we would know the final outcome of Brexit by Saturday – either the deal struck by Boris Johnson and the EU would be passed by Parliament, otherwise a general election likely loomed, delaying Brexit until well into 2020. Well, that turned out to be too hasty, ultimately there was no Brexit vote to be had after MPs voted to delay approval of the Brexit deal and force the Prime Minister to ask Brussels for another extension. As it stands, there is no election planned, another vote on the deal is likely, there is still a chance that we could leave the EU on 31stOctober, and Parliament may try and win a second EU referendum. The list of outcomes seems to be endless; this week is likely to be another busy one for the FX market.
Finding certainty amidst all the confusion
The only certainty that we have at the moment, is that the UK is unlikely to leave the EU without a deal, which eliminates a major fear for the FX market and a key factor that weighed on sterling since the referendum vote in 2016. This is why we remain fairly upbeat for sterling, even though there is widespread concern that sterling could topple from the near $1.30 highs at the start of this week on the fact that confusion remains high after Saturday’s unusual Parliamentary session. So, why are we upbeat on sterling, even after the 5% move higher in the pound last week:
1, the prospect of a no-deal Brexit has been put to bed, sterling bulls have been buoyed by this in recent days, and we expect it to continue.
2, Boris Johnson and co. in the government have abided by the rule of the law(the Benn Act) and asked the EU for an extension to our exit date. Although the PM did not seem too pleased to request this extension, it is much better for financial markets and the value of the pound, that the Prime Minister abides by the law and doesn’t go rogue, especially during this very delicate period in the UK’s history.
3, There is likely to be a vote on the Brexit deal as early as Tuesday, and cabinet members as well as political analysts suggest that Boris Johnson could win the vote, albeit by a slim margin. A vote to leave the EU with a deal is another factor to drive the pound higher, in our view.
4, all other outcomes, at this stage, seem pound positive.Even if Labour and other opposition parties manage to pass an amendment that would mean any deal agreed by Parliament would also have to be agreed by the public in another referendum, this is still likely to be pound positive, in our view, as it would probably involve two pound-friendly possibilities: either we leave the EU with a deal, or we don’t leave the EU at all. Thus, the twists and turns in the Brexit saga from here may not be all bad news for the pound.
The BOE could also boost the pound
It is also worth noting, that now that a no-deal Brexit has been ruled out, the prospect of the Bank of England cutting interest rates has also been reduced. This has put upward pressure on short term UK Gilt yields in recent days, which is also pound supportive. While the BOE may have to follow the lead from the US and cut interest rates at some stage in the coming months, there is still likely to be some upside for gilt yields in the coming weeks, as the UK’s exit from the EU with a deal is the investment theme of the moment, and should have further to run, in our view.
Why looking at the bond market is key for FX
We also remain buoyed about the pound’s medium-term prospects from looking at the vast inflows of foreign money into the UK debt market. Foreign ownership of UK debt is almost as large as the position held by UK pension funds and insurers. While some of this foreign flow is due to the weakness in the pound (making foreign purchases of UK debt cheaper), some of it is also a sign that investors are starting to warm to the UK now that a no-deal Brexit appears to be off the table. This is significant. For those who believe in John Murphy’s market theory documented in his book ‘Technical Analysis of Financial Markets’, a must-read in my opinion, then what goes on in the bond market will filter through to other markets down the line. Thus, the fact that investors have already come back into the UK gilt market makes it likely that they will continue to warm to the pound in the medium term.
Where the pound could go next
So, where do we see GBP trading in the coming week? In the short -term volatility could continue to swing around, however, we think that a move above $1.30 in GBP/USD would remove a psychological barrier to further upside and return to a $1.35-$1.40 range could be on the cards. EUR/GBP is also worth watching as technical indicators are now suggesting that further weakness could be in store for this pair. A break below the bottom of the long-term range at £0.85 could be on the cards if the Brexit deal is passed by Parliament on Tuesday. GBP/JPY is likely to be a big winner from further GBP strength, as the yen struggles across the G-10. This pair is at a 5-month high above Y 140.00. A move back to Y 148.00, the high from early May, cannot be ruled out if the positive momentum for sterling remains in place.
In the event that Parliament does vote in favour of Boris Johnson’s deal on Tuesday or later this week, then we would also expect the FTSE 250 to outperform the FTSE 100, as the domestic companies could out-perform those with international reach who may be hurt by the uplift in sterling.
And if Parliament doesn’t vote for the deal…
Of course, if the Brexit deal is not passed by Parliament then we would expect the reverse to happen of everything that we have mentioned in this note.
There are plenty of other things going on in the world right now, however the bulk of trading interest at the start of this week lies in sterling, so forgive this note’s narrow focus. We will focus on the ECB and other central bank meetings in our next note later this week. Until then, good luck trading!