Sterling watchers are in for a treat in the next few months, as the British currency sways from bullish to bearish with the official Brexit day drawing near. With most investors playing a neutral game, the post-Brexit move could see a significant breakout in the direction of the British pound.
The basics are pretty simple. If Britain leaves the EU intact, with a good deal for the country, then GBP is likely to rally, and British gilts are likely to fall. This would reflect the economic fundamentals that the UK economy is likely to receive a boost, pushing business activity forwards, which in turn would likely see the raising of UK interest rates, which, unless you are a UK mortgage holder, would be a good thing. A “No-deal”, which could occur for a whole host of reasons, is likely to see the British economy slump, along with the British currency, and a probable lowering of key bank interest rates.
Trouble is, nobody can really tell what kind of a deal British Prime Minister Theresa May will be able to secure. Initially an avowed “remainer”, Mrs. May has had to essentially build a barrier between the UK and its former European trading allies. Nobody could possibly want this job. Perhaps this is the reason why none of the senior ministers who resigned from her Cabinet have actually put forward a leadership challenge.
For the past six months, Sterling volatility has been stuck in a trading range with players unwilling to commit to future market direction. Statements from key players such as EU Chief Negotiator Michel Barnier have seen dramatic lurches in the GBP market, but these have quickly come into balance as the commitment of traders on both sides dissipated.
As time progresses, it does seem that a “No-deal” is the more unlikely outcome, which suggests that the currency will rally once the UK leaves the EU in March of 2019. But, with a series of key meetings set throughout the winter months, and the approach of the Conservative party conference, the game is really too close to call. Party conferences often bring out the bears, but as Brexit day draws closer, such negative sentiment is being balanced by a potential growth of belief in a UK/EU compromise on many of the key issues that have bogged down negotiations to date.
From a trading perspective, options dealers are seeing increased interest in out-of-the-money call options, which would turn a good profit following a UK/EU Brexit agreement. This would see Sterling rally and UK Gilts take a tumble. However, to the downside, any deal is likely to require many months to come into effect, which is likely to dampen the enthusiasm of any serious upward GBP strength.
To the downside, if indeed no deal is reached, then the Pound is likely to see a significant fall, similar to the 8% drop that occurred in June of 2016 following the Brexit referendum result.
Really, until clear evidence is available of the status of the final negotiations between the UK and the European bloc, then it would be a brave trader who puts their money on the line. As most analysts are saying at the moment, “It could go up, but then again, it could go down”.