Abu Dhabi, UAETuesday 12 November 2019

UK pound set for volatility amid Brexit uncertainty

The fortunes of the British currency hang on tonight's vote in Parliament

Which way will the vote on Theresa May's Brexit plan go tonight? Gaurav Kashyap analyses the possible outcomes and how each one will affect the pound. Photo: Getty Images
Which way will the vote on Theresa May's Brexit plan go tonight? Gaurav Kashyap analyses the possible outcomes and how each one will affect the pound. Photo: Getty Images

Currency and commodity markets were resurgent in January, with equity markets also turning in a strong performance. The year started with an early blip on January 2, however, when tech company Apple shook markets and announced a cut to their earnings guidance.

A wave of risk-off sentiment spanked markets following the news; the Japanese yen was a particular beneficiary as a safe haven asset – gaining 4 per cent against the greenback and appreciating more than 7 per cent against the Australian dollar in a matter of hours. The downside move was exaggerated as a result of heightened selling pressure from algorithmic trading amid scant holiday volumes. A “flash crash” of sorts, the aberration was brief and markets have since recovered to move higher on the month.

Across the board, the US dollar came under selling pressure in January – hitting three-month lows before consolidating at the 95.00 handle. Not much has changed in the US story to suggest a change in the dollar trend - the US government shutdown extended into its third week, marking the longest US government shutdown in history. Amid a mixed US earnings season markets took confidence driven by progress in US-Sino trade talks.

I toned down my dollar bias following a successful 2018 for the greenback; the weight of a more dovish Federal Open Market Committee theme, established in December, should act as a caution for dollar long positions going forward. This view has been reinforced by the markets response to the most recent US nonfarm payrolls employment report.

Seen as the “godfather” of the economic calendar, US NFPs have been a key driver in the Fed’s future rates forecasting. Last year, we saw a slew of improving numbers raise expectation of future rate hikes, and ultimately this would lend support to the US dollar. However, following the shift in the FOMC’s stance in December towards future rate hikes, improving US data is now starting to be seen as an opportunity to ease the rate hiking cycle.

January payroll data showed that payrolls increased to 312,000 in December (well above the expected 178,000) while the overall unemployment rate increased to 3.9 per cent from a previous 3.7 per cent (albeit from an increasing participation rate). Crucially, the average hourly earnings print jumped to 3.2 per cent (after markets expected a slowdown from a previous print of 3.1 per cent) - its highest level since May 2009.

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Read more:

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It was the third consecutive month of wage growth above 3 per cent. This will no doubt make the FOMC and markets take note. The more we see upward price pressure in the US data docket, the more we can expect to see bouts of dollar weakness going forward. Amid the greater themes stemming from political gridlock in Washington and high-risk events across the pond, I still maintain my upward target of 97.00 by the end of the first quarter.

The British pound came into a nice bout of buying in the lead up to the crucial Brexit MP vote which takes place tonight. While this piece was articled well before the vote, let’s see how potential outcomes to this key vote will drive future GBP pricing.

Prime Minister Theresa May’s plan had lacked support in Parliament (and from within her own party) since the first vote was abandoned at the eleventh hour back in December. I expect similar struggles for Mrs May in January’s vote and the most probable situation would see her deal being shot down with weak support.

This would open the door to immediate sharp pound weakness and would see three new scenarios in extension; a heavy defeat to Mrs May could yield a no confidence vote and thus a new election would be called; a second referendum could be called for (which could see a surge in GBP pricing); and a delay or overall revoking of article 50 (again unlikely, however positive for the pound).

The other likely scenario is in the event she loses the vote by a respectable margin, this would not be seen as an end all by markets and could see Mrs May get another shot at negotiations with Brussels. The EU has stood firm that there is no room to renegotiate any terms and it is difficult to see them change their stance. This would see weakness coming into the British pound and Mrs May return back to the UK with similar options - no deal, vote of no confidence, or push for another referendum. This would simply delay the inevitable once again with sharp bouts of pound volatility returning in the short term.

The final, and most unlikely of scenarios, is one in which Mrs May wins the vote. This would pave the way for a potentially orderly exit with pound rallies in the short term.

While scenario one seems the most likely, this would see extended uncertainty in pound pricing through January, and the similar can be said for the first scenario. However as history suggests, it would prudent to wait for the outcome before triggering any new positions.

Gaurav Kashyap is a market strategist at Equiti Global Markets. The views and opinions expressed in this article are those of the author and do not reflect the views of Equiti

Updated: January 15, 2019 02:58 PM

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