Axi Trader Hot Topic: Trading Brexit

Market Analysis /
11 Sep 2018

Introduction - what is Brexit

Back in the summer of 2016, the UK electorate were presented with a referendum to decide whether the country should continue to be part of the European Union, which it had joined back in 1973. The arrangement had removed trade barriers, but also allowed freedom of movement for EU citizens, with global trade deals being negotiated centrally from Brussels. Some saw this as an erosion of sovereignty and also the cause for lacklustre wage growth in the UK in the wake of the credit crisis of a decade ago. The referendum however was binary and gave little consideration as to how the UK would trade if it was to divorce itself from the great European project. Indeed, the UK government was so convinced that voters would be in favour of remaining part of the EU that no advance planning over what an exit would really mean was conducted.

As it now stands, on March 29th, 2019, the UK will no longer be part of the European Union, yet the two sides are still struggling to find an acceptable compromise in terms of future trade relationships. Any glimmer of hope is typically met with a marked rally for the Pound, but the risk of a no-deal Brexit still looms large. What this means is that a whole series of events between now and March 2019 will have the potential to present a raft of trading opportunities.

 

The key players

There are four key players involved in Brexit.

Michel Barnier is the EU’s chief negotiator. He needs to ensure that any deal with the UK doesn’t pave the way for other member states to seek out their own exit strategy whilst also protecting the interests of the remainder of the EU - in 2016, the UK was the third largest buyer of German Exports.

Dominic Rabb is the UK Secretary of State for Exiting the European Union. He is leading negotiations with the EU and replaced David Davis in this role earlier in the summer.

Theresa May is the UK’s Prime Minister and continues to champion the so-called Chequers deal, which was drafted in early July. Despite the proposal finding support amongst her politicians, a number have since resigned in protest and the EU see the idea as unworkable.

Boris Johnson, a key figure in the campaign for Brexit, resigned as Foreign Secretary in the wake of the Chequers deal. He also opposes the deal, curiously providing some alignment with the mindset of Michel Barnier.

A fifth individual worth mentioning is Mark Carney, the current Governor of The Bank of England. His term was due to end in 2018 but shortly after the Brexit vote was made, he agreed to stay on for another year. Amidst fears that a replacement will be difficult to recruit against such turbulence, he is willing to extend his tenure once again.

 

Key events to watch for

September 13th - Theresa May will hold a crisis meeting as to whether the UK is ready for a no-deal Brexit.

September 20th - The EU hosts a heads of state summit, which will indicate if there’s a willingness to negotiate with the UK on terms.

September 30th-October 3rd - The conservative party meet for their annual conference. Will this be the trigger for a leadership challenge over the poor handling of negitiations?

October 18th-19th - the European Council meet. This was the planned date for signing Brexit terms, but it looks as if the deadline won’t be achieved.

October (or maybe later) - UK law makers to vote on the final terms of a Brexit offer.

November 22nd - The UK budget will be proposed potentially including forecasts of how the state of Brexit will impact economic growth in the years ahead.

Beyond this, we also have the prospect of the negotiations with the EU running on towards the end of the year, whilst other moveable events - maybe a snap general election or a leadership challenge in the Labour party - could provide fresh direction for markets.

 

How markets have reacted so far

Sterling has been sliding in recent months. The uncertainty over the UK’s global trade relationships post Brexit means that Foreign Direct Investment has been drying up, softening demand for the Pound. There’s also slow economic growth being seen domestically which has kept monetary policy comparatively lax and the big risk now is that sovereign wealth funds will soon start to liquidate Sterling holdings.

On the back of the Chequers deal being agreed on Friday July 6th, EUR/GBP fell by around 0.5 pence. However, in response to Boris Johnson’s resignation on the Monday Morning, the cross leapt almost a full cent.

On August 29th, Michel Barnier said that the EU was ready to offer the UK a trade deal like no other it had ever struck before, leaving EUR/GBP to fall around 1.3 pence in a matter of hours, although the subsequent dismissal of the viability of the Chequers deal saw the Euro gain ground once again.

Jump forward to September 5th and a rumour of a side deal between the UK and Germany in a bid to ensure a smooth Brexit saw a whole 1 pence fall in EUR/GBP. The fact this news was unsubstantiated only had a limited reversal effect on the currency. The market is clearly ready to celebrate any good news.

Sterling’s reaction of late has also been validating the age-old idea that markets absolutely detest uncertainty. Any clarity over the progress of negotiations is typically serving to provide support for the currency - even if it’s going to be no deal on March 29th 2019, knowing about this early is less negative for the Pound.

 

What to trade?

EUR/GBP may look like the most appropriate instrument, but it’s important to bear in mind that the Eurozone stands to lose - to an extent - from a disorderly Brexit, too. With the US embroiled in its own trade disputes and ongoing political wrangling, there may be some benefit in looking at lesser pairs - GBP/CHF or GBP/JPY - if you’re looking to exploit pure-play Sterling volatility off the back of Brexit. 

It’s also worth looking at the UK100, which mirrors the FTSE-100 index. The key driver here is that with around 70% of profits for these companies being accrued in foreign currencies, any GBP weakness has the ability to automatically bolster profit expectations across the board.

A typical line being reeled out by leading banks is that a no-deal Brexit could see 10% wiped off the value of the Pound, whilst resolving the matter favourably has the potential to add the same , if not more, on the upside. We’re facing a series of events over the next six months, each of which has the potential to deliver meaningful market movements. Short term traders may well want to take a closer look - and for those invested for the longer term, be aware of these potential bouts of volatility and ensure that your trading strategy accounts for this appropriately in terms of margin availability and the level of any corresponding stops.

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