UK markets on edge as Brexit deal splinters

The worst-case scenario for the Brexit deal has been avoided for now, but prospects and markets remain in a state of volatile flux.

UK markets on edge as Brexit deal splinters

Summary

Theresa May remains UK Prime Minister, avoiding the worst-case scenario for the Brexit deal for now, but leaving prospects and markets in a state of volatile flux.

May stays

UK Prime Minster Theresa May is not resigning. That’s the main takeaway from her comments in the House of Commons earlier, though they did not come close to alluding that she is considering her position. So, the worst-case scenario for risks consequent from the UK’s agreement of a Brexit deal has so far not occurred. But a fraught night has been followed by a precarious morning for the government, suggesting the situation is still in flux and could yet deteriorate further. Despite the cabinet apparently having endorsed a Brexit deal on Wednesday evening, a string of resignations followed on Thursday, including the one that we pointed out earlier this week, matters most, that of Brexit Secretary Dominic Raab. He was in the unique situation of not only being a Brexiteer, but also a cheerleader for the deal that was shaping up over several months. Although not directly involved in the negotiations, he had an obligation to at least know their gist. If so, he may not have had enough of a handle until seeing the draft on Wednesday. With credibility, and perhaps integrity, already dented, his resignation was a high probability. The exits of three further junior ministers in his wake should be seen in that context. As such, their departures, whilst grave, are not as consequential.

FTSE 100 loses Brexit immunity

Nevertheless, the additional damage dealt to already fragile sentiment is considerable. There was a 266-pip sterling fall between European open and late morning; close to the biggest one-day drop in five-year gilt yields since August 2016; and signs of a clear reaction from UK blue-chip equities. The latter is unusual in practice. We last saw direct Brexit-induced volatility in the FTSE 100 just after the June 2016 referendum. Whilst the broader FTSE 100 was showing signs of stabilizing at last check, shares of the largest listed British companies with direct exposure to the United Kingdom were sharply lower. Hence, Royal Bank of Scotland, the smaller of the country’s dominant domestic banks fared worst at the time of the market snapshot in the image below. The sense that it might not just be the Brexit deal that is unravelling but also the government, suggests another dimension to the selling: concern that if the Conservative government falls, Labour might replace it in the event of a snap election. Labour has promised to act against what it regards as excesses and iniquitous behaviour of industries like banks, transport, utilities and more. Shares in Barratt Development, which is Britain’s largest residential property developer and a leading owner of undeveloped land and property banked over several years, were third worse off, closely followed by rival Persimmon.

Figure 1 – FTSE 100 snapshot 1122 GMT 15.11.2018


Source: Refinitiv/City Index

Tinder box

With so much uncertainty remaining, as we’ve stated quite often over the last couple of years, there is little more to forecast but further volatility. Now, sterling options, including those in short-term trades, from a week and up to a month, are projecting the highest foreign exchange volatility for two years. Therefore, the pound will continue to be most prone to further fireworks in reaction to further developments. Those developments now look unlikely to include the immediate beginning of an end of Theresa May’s term as Prime Minister. But further echoes from Conservative rebels, or even (though less likely now) more government resignations will almost inevitably exercise sterling and other assets further. On the other hand, with May weakened and the numbers capable of mounting a Conservative leadership challenge according to party protocol (48) possibly bolstered, the Tory party will be pivotal for what happens to the Brexit deal next. Markets can be expected to pay rapt attention to Westminster.

Sterling off the floor

Sterling collapsed by about 2.5% between last night and late morning. A short while ago it was attempting to re-take one of the key supports it sliced through on the way to new November lows. Still, one of the most remarkable observations about the pound right now is that despite huge volatility and momentum, underlying support is evident. Traded against the dollar, sterling has not set a new 2018 low since August, having last come close to doing so at the end of October. Unfortunately, though, under the circumstances, the best way to look at the anomaly is that it suggests fuel remains in the tank for sterling to plunge much further. This will almost inevitable occur in the event that the worst-case scenario for the Brexit deal appears to inch closer.

Figure 2 - Technical analysis chart: sterling/U.S. dollar – 30-minute intervals

Source: Refinitiv/City Index

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.