Is the FX market jumping the gun on a tidy Brexit?

Sterling is the currency to watch this week, surging by the most in two years late on Wednesday as the British parliament held yet another Brexit related vote, which included the passage of a non-binding amendment to ensure that the UK will not leave the EU without a deal in place. This is an interesting development, did the FX market realise that this was a non-binding vote, thus the UK could still leave the EU without a deal? Or has the market concluded that the UK government is now in the hands of 650 raucous politicians, and Theresa May dare not disagree with their wishes?

Either way, the market is reacting positively to the prospect of 1, the UK leaving the EU with a deal in place, and 2, the potential of a delay to Brexit, which could (at the margin) see the whole process scrapped or reversed if the can is kicked far enough down the road. The gyrations in sterling, which led to GBP/USD rising to its highest level since June 2018, at 1.3370-80, is not a sign that the market is warming to the idea of the UK leaving the European Union; if the prospect of a no-deal Brexit comes back on the table then we believe that the pound will suffer. This was evident in overnight trading. Once the dust had settled on the votes in Parliament, GBP/USD started to experience some volatility around the $1.33 mark, suggesting some hesitancy to push sterling above this level as traders started to re-assess what a non-binding vote actually meant.

MV3 anyone?

FX traders have another round of votes to contend with, after the Prime Minister scheduled a third meaningful vote for next week on her original Brexit deal, days before Mrs May is scheduled to visit Brussels for an EU leaders summit. Will MV3 (meaningful vote 3) be rejected yet again, or will it be third time lucky for Theresa May? Even if she loses next week’s vote, we still don’t think that the market will price in the prospect of a no-deal Brexit straight away, even at that late stage, as we would then expect the UK to seek an extension to the Brexit deadline from March 29th to June 30th, something the EU is sure to agree to.

Is the pound “bovvered” by Brexit?

It is worth remembering that the FX market has a short attention span. While a reasonable person can see the absurdity of the whole situation: the UK parliament now has control of the Brexit process, which means that 650 UK MPs are engaged in rounds of votes that, so far, show no sign of consensus or progress, FX traders are still happy to buy the pound because the situation is better than it was yesterday. However, if the Brexit situation deteriorates tomorrow, then expect the pound to fall, and for this pattern to continue. This market is driven by sentiment, and GBP sentiment is currently driven solely by what is happening in Westminster.

Signs of life for GBP

As we mentioned earlier this week, the market’s sensitivity to Brexit appears to be moderating. Speculative short GBP positions, as measured by the CFTC, have fallen sharply as we lead up the UK’s exit from the EU, and implied volatility in the one-month GBP/USD option has also declined compared to a week ago. This is suggestive of a few things: firstly, the market is wise to the dealings of the EU, and it won’t take a directional view on the fate of sterling until the last minute of negotiating time is over. Secondly, there is a growing expectation that Brexit will be delayed. Parliament will get to vote on this later today, and we could see an extension period of 1-2 months’, which is considered by the market enough time to get a deal over the line.  Thirdly, the market may also be assessing how bad a no-deal Brexit will actually be, especially as both the European and British governments start to make plans to ensure the softest landing possible if a no-deal Brexit becomes the only option on the table.

Is a no deal Brexit really that bad?

The UK is set to slash import tariffs on the vast majority of goods coming into the country on the back of a no-deal Brexit, with 87% of all goods facing zero tariffs, thus reducing the prospect of a surge in inflation post a no-deal Brexit. Thus, at this stage, the market seems confident that a deal will be reached (either by 29th March, or after an extension), and even if there is no deal, then the politicians will assuage the situation for the economy. This is easing panic in the market, and also giving investors confidence to see the bright side for the pound. Pound bears need to trade carefully in the short days, as the pound decline that they envisage may not happen.

Spring Statement fails to burst sterling’s balloon.

The Spring Statement from the Chancellor was, as anticipated, a damp squib for the markets. Not even a serious slashing of the UK growth targets from the OBR, to 1.2% from 1.6% for 2019, was enough to knock the wind out of sterling. The Chancellor did use the statement to lambast the House for not backing Theresa May’s deal, saying that a dark cloud hung over the UK economy, he also tried to bribe them to agree to the deal at a future vote, saying that he would only unleash a £20 billion package of tax cuts and spending plans if the UK manages to get a deal. It is highly unlikely that the ERG will listen to Phillip Hammond, however, his message may have helped put a shine on sterling late yesterday afternoon.

Overall, our base case for sterling in the coming days is that it will continue to rally, as long as the prospects of a deal or a delay to Brexit remain on the table. In this scenario we could envisage a move back towards $1.35 for GBP/USD in the medium term.

US stocks overview

We mentioned earlier this week that the S&P 500 was ripe for a recovery. This was indeed the case, with the US market rising from a low of 2,725, rising above 2,800 to 2,820. However, the index has stumbled around the 2,820 mark, which is a noted area of resistance. 2,815-20 has been hit three times in a month, on 25th Feb, 4th March and on Wednesday, and is a key level of resistance dating back to November. The fact that the market keeps testing this resistance level, suggests that there is a desire to break above it, however investors bottle it at the crucial moment.  We may need to see a combination of a dovish Fed and decent US economic data to push this index above this key level.

Can Boeing continue to recover?

One thing we hadn’t expected was for the Dow to outperform the S&P 500 on Wednesday. The Dow was given a major boost by the late surge in Boeing’s shares. This came on the back of the announcement that Boeing was grounding all of its 737 Max 8 jets, after two fatal accidents in 5 months. After dropping to a low of $363, the shares rose above $377, as the market reacted positively to the decisive action taken by Boeing. If Boeing can prove that it is dealing with the problem, which could see the jets reinstated, then there is no reason why the Boeing share price may not claw back further losses as we move towards the weekend. Overall, while the situation for Boeing is serious, it has moved on from being catastrophic and alarming, which may allow the stock price some more time to recover, and giving the Dow Jones a short-term boost.

Ahead today, US jobless claims, Chinese data and German CPI are all worth looking out for.