Messy Brexit can result in the same situation as it was in summer 2016.
When a currency ignores economics and is being affected by political factors alone, anticipating its rates looks like fortune-telling. One matter is when you try to figure out the central bank’s next measures by means of analyzing statistics; another matter is when you try to anticipate how they will vote in the referendum, whether the Parliament will support the draft deal with the EU, and if the UK is going to face a snap election. From the fundamental point of view, the GBP is the most undervalued currency in the G10; however it can well slide down to $1.2 in case of messy Brexit. Therefore, the increase in its volatility up to its 17-month high is seen as a matter of course.
Dynamics of GBP volatility
Source: Bloomberg
Bulls’ optimism has failed to meet the reality: following five-hour with her cabinet, Theresa May won the support; however, the GBPUSD failed to consolidate above the psychologically important level of 1.3 due to the talks about possible dismissals of the dissent officials, a challenge to her leadership, and a rebellion in the Parliament. And Credit Agricole (PA:CAGR) expected the pound to rise above $1.32...
It is unknown what exactly was going on in 10 Downing Street; but it can be assumed that Theresa May had really frightened the ministers. Rumour has it that everybody in the Cabinet was satisfied with the agreement, proposed by the Prime Minister, but almost everybody answered the question of whether the alternative plane was worse in affirmative. However, the sterling itself was scared by the fact that the dissenting officials were going to resign. Everybody remembers that after the Brexit secretary David Davis had resigned, followed by the Foreign Secretary Boris Johnson, the GBPUSD bulls faced real troubles, even though the Government had supported Theresa May’s plan.
Obviously, there will always be someone who won’t agree. 40% of the incomes, generated by the UK companies, included in FTSE 100, are associated with the US dollar. Therefore, they should benefit from the pound’s weakness. On the contrary, the locally oriented corporations should be happy with GBP revaluation. Nowadays, almost each politician is backed by the big money; so the vote in the Parliament is going to be really hot.
Dynamics of GBP/USD and FTSE 100 Index
Source: Bloomberg.
Will Theresa May manage to frighten the legislative branch of power as much as the executive? Even the opponents of close cooperation with the EU understand the results of the no-confidence motion in the Prime Minister or the rejected draft agreement with the EU. Hardly anybody wants to face the turmoil, resulted from messy Brexit. But, in 2016, many were suggesting that the divorce will plunge the country into chaos. Can the GBP/USD really crash as dramatically as it was 2.5 years ago?
I believe that the best strategy in the current environment is to just watch; at least until the GBP/USD pair is up above 1.32. The optimists will still have an opportunity to buy the GBP after the deal is ratified at the EU summit on November 25 and the UK Parliament approves it.