Will the UK get a Brexit boost?

The pound is already one of the best performing currencies this year.

With macro watchers so intently focused on US-Sino relations, the massive credit expansion in China and communication changes from the Fed, it’s almost too easy to forget we are in the pointy end of the Brexit negotiations.

In reality, trading around Brexit has been confined to UK assets and is a relatively niche event risk for market participants. The news flow has affected UK interest rate pricing, and, of course, the GBP, while the FTSE 100 has performed in-line with other global equity markets, with a gain YTD of 8.5%, that is, when priced in AUD terms.

We also find the GBP has been the standout currency in G10 FX in 2019 with a gain of 4%, just ahead of the CAD, which has naturally been bolstered by the rampant moves in crude since October. The question is, could the GBP could be the superstar currency for 2019?

Trading considerations for the GBP

Well, the signs are certainly promising and momentum-focused FX traders, most of which are the automated (algorithmic) crowd, would already have a decent exposure here. Owning GBP is by no means a crowded position though, because if we look at the options market, we can see a strong bearish skew, with strong demand to own GBPUSD ‘puts’ over ‘calls over any time frame. If we also look positioning in FX futures, we can see the speculators are still holding a sizeable net short position on the GBP. So, on positioning (in FX options and futures) alone, should we get clarity that Brexit heads to a favourable outcome, then the GBP has every chance of being the best performer in G10 this year, and this is my current view.

With this in mind, holding exposure to UK assets unhedged could be an excellent investment for 2019. For Aussie investors, we can already see the GBPAUD cross rate testing the highest levels since 2016 and has the potential to crack A$2.0000 this year.

Should we see a positive resolution to the negotiations, a further kicker will be what happens to UK interest rate pricing. At present, the market has pencilled in the next rate hike from the Bank of England for mid-2020. Should we see signs though of a more certain outlook for both UK consumers and businesses then this pricing will quickly alter for a hike in Q3 2019.

The timetable from here

In a world of deadlines and uncertainty, we have to work off probabilities in trading. Now, assessing everything we have heard of late, my current base-case is that Theresa May’s deal will pass on the 13th March. That’s a big call, and the caveat I hold here is that it is conditional on UK Attorney General, Geoffrey Cox, perhaps the most important person in this whole process now, obtaining a legal codicil that he personally rubbers stamps.

Should he make his way back from Brussels with this concession by, say, the 11th March, and he assures parliament that the Irish backstop would not be permanent, then this is a game changer. It’s at this point GBP will price in a passed vote in the Commons, and we will see the GBP rally on the headlines. GBPAUD is on the radar, although I’d expect our client flow to be centred firmly on EURGBP and GBPUSD. GBPUSD should push through $1.3500 and even into $1.3600.

Cox’s legal assurance would undoubtedly be enough for the Democratic Unionist Party to back May’s deal. The ERG (European Research Group), via an interview Jacob Rees-Mogg made in the FT, detailed that the group would be open to voting on May’s deal, should we see an appendix added to the Withdrawal Bill. We may even see the more moderate factions in the Labour Party, what’s left of them, vote for the deal and this is where we then get the numbers for May’s Withdrawal Bill.

Article 50 extended

Should my base case play out, the focus then turns to the following morning when the Commons vote and subsequent request to extend Article 50. This should comfortably pass, and the question of whether the EU give their blessing is the next step, which if May’s deal passes is practically a no-brainer for the EU.

Geoffrey Cox is the key player

Of course, Mr Cox may not get the assurance that I have stipulated, in which case the vote on the morning of the 13 March will likely fail, and the market turns to the EU’s subsequent reaction to the UK Common’s request to extend Article 50. Without a clear plan to form an agreed deal, volatility in the GBP should ramp up on uncertainty alone, and the prospect the EU reject the extension increases, although the group really don’t want a no-deal Brexit. They will, however, be very keen to assess the prospect of a second referendum or a general election, which puts the UK closer to what EU negotiators always have truly desired — no Brexit at all, which is the outcome the likes of Juncker and Tusk have been pushing for.

On balance though, I see a real risk here that Geoffrey Cox will get the legal assurance on the duration of the backstop that should help achieve the number for May’s deal to pass. How much is already priced into the GBP is one thing, but positioning and rate pricing, tells me that there is good upside if my base case plays out.

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