The Smart Money?
With the UK’s Chancellor of the Exchequer suggesting in Davos that should the UK leave the EU at the end of March without a deal it would cause "very significant disruption" and cabinet ministers being openly critical of the idea of the UK allowing a “no deal” Brexit to happen, perhaps the recent strength of Sterling against the Dollar and Sterling is due to Forex investors reading the tealeaves.
Given that every serious commentator says that a disorderly Brexit would cause a run against Sterling and that the British PM has reacted to parliament’s massive and historic rejection of her withdrawal agreement (plan A) largely be re-badging it as Plan B, Sterling should be sliding lower, but it’s not. The British currency started the year at 90.3P to the Euro (3/1/19) but this was prior to the “meaningful vote” when some pundits might have imagined that May’s deal would squeak through as being the “least bad” alternative. Since the eve of the vote, the Euro has slipped from 90.4P to stand at 87.08P (yesterday) whilst the UK government has done a very commendable impression of a headless chicken. Conventional wisdom would suggest that it is defying gravity.
The chances of Mrs May getting Plan B (or A) through parliament without the EU agreeing to remove the so-called backstop from the withdrawal deal are negligible. Neither the DUP nor the ERG seem willing to climb down from their positions of outright rejection of it. The EU is adamant that this will not happen and that negotiations are at an end. Many in the ERG would prefer to see a “no deal” Brexit than the compromise deal that May has brokered and that, currently, is the direction of travel. It is also hard to see how the opposition position to the deal can be changed without May agreeing to a permanent customs union which may spur new discussions with the EU. Should she do this, it is thought that she would trigger a schism within her own party. Many in the Labour party are opposed to Brexit, so it is uncertain if Corbyn could carry his MPs to support such a deal in the first place.
So the big question is why hasn’t Sterling fallen to new lows rather than rallying against the Euro and the Dollar? Fundamental analysis says it’s headed in the wrong direction. If you want to make a killing on Sterling as it tanks on a “no deal” outcome, you need to get out of it now to a safer bet (the Swiss Franc or the Yen, perhaps) to be in a position to gain from shorting the Pound. It is true that the Swiss Franc and the Yen are gaining against the Euro, but that isn’t the case against Sterling. The answer to this is that investors think May is bluffing and that a no deal Brexit will not happen. This can only happen, for certain, if May rescinds A50 notification and the UK remains in the EU after the end of March.
Whilst parliamentary moves to force May to prevent a hard Brexit could bear fruit, as Michel Barnier pointed out, extension of A50 notice is not a given, so parliament is powerless to force this outcome. Another possibility is that the UK calls a further referendum despite the current objections from May and dithering from Corbyn, but this doesn’t automatically stop a no deal outcome either – the UK would need to ask the EU to extend the notification period to allow the vote to take place (something the EU would almost certainly agree to).
It may be that a substantial part of the Forex investment community has concluded that May is bluffing and will not allow the UK economy to suffer self-inflicted and avoidable harm if her deal cannot be saved. She has the decision to rescind A50 notice in her own hands and has intimated to hard Brexit supporters that failing to back her plan A/B risks there being no Brexit at all. Should this happen, fundamental analysis would suggest that Sterling will rise in value, not fall.