Article 50 and Indyref2: no problem for the pound

<p>It’s been an interesting day for the UK, speculation is growing that Theresa May will trigger Article 50 on Tuesday, after a bid by Europhile […]</p>

It’s been an interesting day for the UK, speculation is growing that Theresa May will trigger Article 50 on Tuesday, after a bid by Europhile MPs to block the Brexit bill looks set to fail. Then there was the announcement that Scotland will seek to hold a second independence referendum.

Pound performance undeterred by political risks

We are about to enter the thick end of the Brexit negotiations and the UK may be broken up but the pound is the strongest currency in the G10 so far today and the FTSE 100 is one of the leading European equity performers. The reason that UK asset prices have been able to bat off Article 50 concerns and a Scottish independence vote so easily is all about expectations. The market may actually experience a sigh of relief once Article 50 is triggered, at least it gets rid of the uncertainty, and we always knew that it was going to happen by the end of March, so a couple of weeks’ early isn’t going to cause panic in the currency markets.

Too early to price in Scottish independence?

A second referendum for Scotland is also not a key event risk for UK asset markets right now for a couple of reasons: firstly, Nicola Sturgeon didn’t give an actual date for this referendum, it could happen sometime between 2018 and 2019, which is probably too far in the future for the markets to start worrying and pricing in the break up of the United Kingdom. Also, the latest opinion polls suggest that a second referendum would go the same way as the first, and the majority of voters would choose to stay in the United Kingdom. While opinion polls still can’t be fully trusted, it’s enough, at this stage, to keep UK markets calm.

A word on positioning

Market dynamics are also at play at the start of the week. The latest speculative positioning data from the CFTC showed that the number of GBPUSD short positions last week rose for the fifth straight week to their highest level since November. With the FOMC meeting and Dutch elections this week, perhaps the market is too bearish on the pound on the back of Brexit and indyref risks that could take years to materialise?

We don’t believe that the triggering of Article 50 will, by itself, be negative for the pound, of more concern will be the European Union’s reaction to it and their stance during the Brexit negotiations, which we won’t know for a few weeks. While there are many longer-term risks for the pound, in the short term, we think that GBPUSD could extend gains to 1.24, especially if the Fed dot plot on Wednesday is not as hawkish as some expect. Cable is also due a reprieve after eh UK-US yield spread reached a record low. While this yield spread is still sterling negative, at these extended levels we should expect a pullback.

Euro risks on the doorstep

The pound also looks like it could stage a meaningful recovery versus the euro, where political risks in the Netherlands are literally on the doorstep. In EURGBP a retreat to 0.85 – a cluster of moving average support –  could be on the cards.

All eyes will be on Theresa May tomorrow, if she fails to trigger Article 50 we could actually see some sterling weakness, as the market might be disappointed that the time for Brexit negotiations to begin have been delayed. It’s a funny old world…

Join our live webinars for the latest analysis and trading ideas. Register now

GAIN Capital UK Limited (trading as “City Index”) is an execution-only service provider. This material, whether or not it states any opinions, is for general information purposes only and it does not take into account your personal circumstances or objectives. This material has been prepared using the thoughts and opinions of the author and these may change. However, City Index does not plan to provide further updates to any material once published and it is not under any obligation to keep this material up to date. This material is short term in nature and may only relate to facts and circumstances existing at a specific time or day. Nothing in this material is (or should be considered to be) financial, investment, legal, tax or other advice and no reliance should be placed on it.

No opinion given in this material constitutes a recommendation by City Index or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person. The material has not been prepared in accordance with legal requirements designed to promote the independence of investment research. Although City Index is not specifically prevented from dealing before providing this material, City Index does not seek to take advantage of the material prior to its dissemination. This material is not intended for distribution to, or use by, any person in any country or jurisdiction where such distribution or use would be contrary to local law or regulation.

For further details see our full non-independent research disclaimer and quarterly summary.