Brexit – a new era begins. Market trends to look out for

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Updated: 31 January 2020

 

  • Friday saw Laura Kuenssberg, political editor of the BBC, ask: “What will change on the day that the UK leaves the EU?” Her answer: “Everything and nothing.”
  • The official departure, which occurs at 11pm on Friday 31st January, is followed by an 11-month transition period but does also mark the start of a period of radical change.
  • Uncoupling from a political, legal and economic structure that has been in place for over four decades brings uncertainty for the financial markets and, with that, price volatility.
  • Reference to the market moves since the referendum shows that for those who got on the right side of trades, Brexit was the gift that kept on giving.
  • The 11-month transition period is a tight timeframe for the negotiating teams, meaning that the roadmap of the upcoming events could identify key trigger points.

 

The official exit of the UK from the EU will be marked by both celebrations and protests. The differing reaction to the event highlights the divisions that the process has created. In the three years prior to the December general election, the strength of contrasting opinions meant that the likelihood of Brexit actually happening was always in doubt.

Source: CNBC

The sterling-dollar forex pair, which became the de facto measure of Brexit, saw GBPUSD move from a high of 1.50173 in June 2016 to as low as 1.13001 in October 2016. The retracement to 1.43449 in January 2018 was followed by further falls, with the pair now trading mid-range at 1.31082.

GBPUSD – Monthly Candles – 2014-2020

Source: MetaTrader

The price moves have seen long-term trends become firmly established. The forex pair comes with tight bid-offer spreads, relatively low financing costs and high levels of market flow, the GBPUSD pair madeup 9.6% of daily forex transactions in 2019. They created opportunities for traders to enjoy the ride down and indeed the rideback up. There were also plenty of windows to trade the retracements brought about by the ever-changing news flow. Managing positions through the move down and then back up could have added to returns, but the core move reflects a 24.75% downwards price shift followed by a 43.45% upwards move, in the space of 18 months.

GBPUSD – Weekly Candles – 2017-2020

Source: MetaTrader

The announcements being made by the UK and EU officials are largely courteous. Both sides appreciate the pitfalls associated with not being able to reach a workable agreement. Should an agreement not be forthcoming, then on 1stJanuary 2021, the two massive trading partners will revert to WTO terms and, after years of posturing, bring about a no-deal Brexit. The clues to the likelihood of that happening will appear through the coming months, but there appears little reason to think that the deliberations won’t carry on right up to the wire.

Lee Ferridge, head of macro strategy at State Street, told CNBC on Wednesday that the market is underestimating the potential for any trade agreement between the UK and the EU.

“I still don’t think the market is really factoring in that in theory the no-deal risk is gone, because there is a deal now, but when we were talking about the no-deal Brexit, what people were really talking about was ‘what’s the trade agreement? What is the future trade relationship?’”

Source: CNBC

The analysis by Ferridge and his team at State Street sees the door open to sterling weakness:

“There’s got to be every risk that sterling falls back to those low 1.20s we saw before, particularly if growth stays low.”

Source: CNBC

 

Dollar

Recalling that the currency pair is made up of two currencies will also need to be factored in. The US dollar has been tipped by some analysts to show weakness through 2020. The US presidential election taking place later in the year will add to the uncertainty. From a fundamental perspective, there is also some likelihood that the US Federal Reserve may cut interest rates to curtail sluggish economic growth.

Piotr Matys, currency strategist at Rabobank, said:

“We’ve held a constructive view on the dollar for two years and expect it to hold relatively steady in the first half of next year, then weaken as we think the Fed will have to cut rates again.”

Source: Capital

Any progress made in the US-China trade talks would work in the other direction, with the dollar being seen as a ‘risk-on’ asset.

 

Kick-off

Brexit negotiations are due to start on 3rd March, which appears to be building in a delay to a situation that some commentators describe as being on a ‘knife-edge.’ Posturing and speculation is, of course, likely to distort the markets even before the two teams sit at the same table. GBPUSD has since traded in the region of $1.30, and any moves away from that level may be seen as temporary in light of the talks starting in earnest some weeks later.

Source: The Telegraph

 

When the UK government’s EU adviser, David Frost, and head of EU negotiations, Michel Barnier, finally meet on the first Tuesday in March, they will have a range of hot topics to consider. Top of the agenda will be the passporting of financial services, fishing rights and free movement of trade. The EU is faced with ensuring that the terms of the new agreement do not favour the UK to an extent that other members also consider leaving the union. This task is complicated by the balance of payments between the two parties favouring the UK, which buys more products and services from the EU than the EU does from the UK. The EU does not have a zero-tariff, zero-quota, traditional free-trade agreement with any country in the world and would be reluctant to offer one to the UK.

The March talks should confirm what each party considers their ‘red lines’ – or at least their starting positions in preparation for rounds of horse trading likely to fuel market activity.

 

Forecasts

The role of official data should also be kept in mind. Economic forecasts in the run-up to the referendum and indeed ever since have tarnished the reputation of economists. The doomsday predictions, which were labelled ‘project fear’, didn’t materialise, but UK GDP growth in 2017 was 1.8%, having previously been forecast to be 2.3%. In the run-up to the UK actually leaving the EU, the consensus among analysts is that GDP growth in the UK will be lower than if the break-up wasn’t happening. The release of such reports is likely to cloud the picture, but by doing so, also open up trading opportunities.