Global Head of Macro Strategy
Summary: Sterling is on the defensive as the No Deal Brexit risk is now being taken far more seriously, even if a cliff-edge of implementing new terms is hopefully unlikely. The euro may stumble versus the USD and JPY here if a hard Brexit comes into play. Elsewhere, trading AUD at the moment might as well be a speculative play on Chinese iron ore futures, which have gone parabolic in recent days on top of a strong run higher.
Today’s FX Trading focus:
Brexit crunch time is here – what does "No Deal" actually look like=
The latest statements from UK Primes Minister Boris Johnson and EU Commission President Ursula Von Der Leyen raise concern that we are headed toward a Brexit with no real deal in place. Johnson told his country to prepare for a No Deal and the Von Der Leyen echoed this comment today. But what does an actual “cliff-edge” or No Deal Brexit actually look like? Surely we are not faced with the proper “cliff edge” scenario, with lorries backed up at the border and the chaos that many have feared but a more pragmatic process in which negotiations continue on how the UK and the EU get from here to a post-Brexit there on basic WTO-like terms, or something resembling the deal between the EU and Australia. Neither side has any interest in immediate further disruption of any sector of the economy in the heart of the darkest days of a pandemic.
Regardless, the market will have plenty more sterling selling to do if it is clear that we are headed for a no deal, even if that no deal destination results in a further extension of a phased transition period over perhaps another six months or a year or more on some issues. On that note, GBPUSD is vastly preferred to EURGBP for expressing GBP downside, as any No Deal will negatively impact EUR sentiment as well.
Recall that this Sunday is meant to produce an announcement on the state of negotiation and whether these will continue. The most reasonable scenario if we are headed for a No Deal Brexit, would be an extension of the current transition period terms (no change to customs arrangements, etc.) to give time to hash out the path to semi-WTO terms by the end of next year. This might soften the blow to sterling.
If, on the other hand, the whole situation has been an exercise in brinkmanship and the EU gives in at the last moment to salvage a deal, we could see a tremendous knee-jerk rally in sterling – can’t rule that out entirely. But I don’t understand how a sudden deal is achieved this late in the game however – why bother to go through the theatre of the recent Johnson/Von Der Leyen dinner etc, only to suddenly change positions at the last moment?
Chart: GBPUSD
With the risk of a somewhat binary outcome this weekend, when we supposedly get a headline indicating next steps for the Brexit process. Assuming we aren’t headed toward a proper “cliff edge” scenario, sterling downside on the prospects for a transition to WTO terms may prove semi-orderly after an initial gap lower. The first key pivot level is the important 1.3000 level ahead of the major 1.2750 support and 200-day moving average.
The G-10 rundown
USD – I outlined the last remaining hurdles for the year for USD bears in my Wednesday update. One of those receding at the moment is the long yield in the US, which declined yesterday on a strong 30-year T-bond auction result. The stimulus question and FOMC meeting and general risk appetite remain open questions. On a side note – the sidewise USDCNY is a bit of a concern for the USD bearish position as well.
EUR – the ECB delivered what was expected yesterday at its meeting, announcing a EUR 500 billion expansion of its QE programme and extending the horizon of purchases to March of 2022. More generous terms on TLTRO bank lending were also announced, including an extension of 12 months for the current favourable terms and new emergency LTRO’s to be offered next year as a liquidity backstop. Somewhat oddly, President Lagarde said that not all of the EUR 500 billion for QE need be used if conditions improve sufficiently, which some might see as hawkish. Elsewhere, it appears she tried to talk down the euro a bit with a comment that the ECB is watching the exchange rate closely.
JPY – the yen standing by in the wings to passively absorb strength on any sudden shift to the downside in risk sentiment – whether driven by hard Brexit concerns or otherwise.
CHF - the uptick in Brexit concerns seeing an uptick in CHF as a hedge against both GBP and EUR weakness. Assume that the SNB will robustly defend 1.0700 in EURCHF, after sight deposits have actually dropped over the past three weeks.
AUD – the AUD strength clearly driven by an incredible ramp in Chinese iron ore futures – have a hard time believing this can continue in the nearest term.
CAD – technically, the path to 1.2500 and lower has been opened in USDCAD – just having a hard time ginning up enthusiasm here if oil price momentum fades and risk sentiment takes a breather – some risk of consolidation, in which case 1.3000 is the major chart resistance.
NZD – still we like AUDNZD from a value angle since 1.0500 even if iron ore cools and the 200-day moving average at 1.0650+ holds back the pair in the shortest term.
SEK – assuming a solid recovery next year, we like EURSEK lower, but would prefer to pick spots, wary that a squeeze is possible above 10.30 in the near term if we finally see a more notable consolidation in risk appetite.
NOK – the momentum has come out of the NOK despite the Brent price north of 50 – need a proper follow through higher for ex-US risk sentiment and crude prices for a more notable NOK rally – still like NOK for 2021 eventually, however.
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