Brexit hopes prop sterling

Summary

For the second time in two years the British government is on the brink of collapse, but markets are, overall, buoyant.

London shares resilient

By mid-session the FTSE 100 stands 1.3% higher. It has strengthened steadily since open and only around a tenth of its shares are trading lower. Of these, most are down less than 1%. At least one, oil field services provider Wood Group, which fell as much as 10% earlier, is reacting to concerns unrelated to Brexit. The mid-cap FTSE 250 gauge is also up 1.3% despite more of its companies making more revenues in the UK and, consequently, tending to be more sensitive to UK politics. Only the FTSE 250’s December futures contracts, expiring Friday week, betray that something might be up with a small fall. Prime Minister Theresa May has just begun a session of PMQs and it could be one of the most fraught for years. Still, it’s unlikely new shocks will emerge, so markets can be expected to remain resilient.

Figure 1. Snapshot: FTSE 100 - FTSE Future - FTSE 250 - 12/12/2018 12:32:29

Source: Refinitiv/City Index

Further afield, stock markets are also a clear sea of blue with all large European markets positive. They’re tracking a robust equity session in Asia, encouraging Wall Street futures to rise too. In short, if the Brexit crisis is coming to a head, there’s something about the way that’s happening that’s keeping a lid on panic.

'Bremain’ in play

True, the biggest driver of the rebound is that investors are beginning to buy Washington’s take on trade talks. But make no mistake, news that enough Conservative MPs have submitted a letter to trigger a No Confidence vote in is seismic. But markets have long been willing to look past heightened hard Brexit risk if events take a turn that could avoid Brexit entirely. Such thinking looks to be in play again. For one thing, whilst Theresa May has pledged to fight the confidence vote with everything she’s got, she has also toughened warnings to Brexiteers about the chance of a No Brexit. Her statement earlier noted that a new leader “wouldn’t have time to renegotiate a withdrawal agreement…so one of their first acts would have to be extending or rescinding Article 50, delaying – or even stopping it”. At the same time, remain campaigners have dropped support for the ‘Norway-plus’ alternative Brexit deal to concentrate on a second referendum. Senior opposition Labour Party figures, officially neutral to the idea, have moved almost to full endorsement. Leader Jeremy Corbyn said on Sunday that another referendum would have to be "qualitatively different to the one held before".

Sterling up for air

Optimism is even showing in sterling, the market most sensitive to Brexit. The pound traded against the dollar was up some 60 pips from latest 20-month lows just now. This is partly due to profits being realised on short trades. But the motivation to do so in itself also reflects a growing assessment worst-case risks are decreasing. The technical price chart of sterling traded against the dollar below shows the market is inching within the range where selling was most intense this week (see ellipse). The probability of clearing $1.266 resistance looks quite low. Optimistic instincts aside, sterling could yet fall further in the near term.

Technical analysis chart: sterling/U.S. dollar: two-hourly intervals [12/12/2018 12:32:17]

Source: Refinitiv/City Index

To be sure, at no other time since the Brexit vote has trading in the pound been this chaotic, with huge falls against the dollar, euro, yen and other major currencies since the end of last week of between 1%-2%, far higher than usual. Implied volatility in sterling options trading, which projects how wildly the pound will gyrate, was beginning to cool off in trades covering the festive season. Now demand for such contracts and others covering the next few months, is accelerating to new two-year highs.

What next?

Indeed, whilst bookies odds point to a Theresa May win, what if she doesn’t? Sterling’s Brexit link would obviously be in full effect in that scenario. With a near-perfect storm of volatility on tap, psychological vagaries could easily see the pound spike to near $1.20. And whatever the outcome of tonight’s vote, within months, the effects of the currency’s latest collapse will show up in the economy, in inflation, interest rate expectations and growth. The feedback loop to the pound could keep it under pressure. With no obvious candidate to succeed May within the Conservatives, her defeat would not reduce uncertainty before the end of March. If she wins, the best conditions for sterling would be if the tally of those voting against her is low. The threshold required for a no confidence motion to be carried is 158 out of 315 Conservative MPs. If less than 100 vote against May, pressure for her departure would diminish, if not evaporate. We would then be back where we were at the beginning of the week, when things were barely more certain.


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.