Sterling rises on May’s resounding defeat

Prime Minister Theresa May’s unpopular Brexit deal got a worse thumping than many predicted and everyone is now scrambling to understand the next steps. I won’t pretend that I can add much to the noise on what comes next, but agree with the consensus that May avoids falling in a Labour-instigated confidence vote today and that this means no new snap election is in the making.

As well, popular sentiment suggests extremely low support for a second referendum. Assuming May survives the confidence vote, we’ll need to shift the focus to what comes from May’s revisiting the deal with her European Union counterparts, now with a bit of added leverage from the size of the deal’s defeat.

I would expect the EU leadership keeps its head firmly buried in the sand and little or no sign of a shift in their position. Another idea is that May will pursues “cross-party” talks with the opposition on what to do next, which makes eminent sense, given that Brexit sentiment cuts straight across party lines – but the question begs whether the political atmosphere in the UK is too dysfunctional for any coherent plan to emerge.

Finally, there is the issue of an Article 50 delay where the complacent assumption is that it will be extended. Something bothers me about the strength of that consensus, but one could also argue that the endgame results in a “no deal” after all, though a no-deal with a number of bells and whistles to soften the impact, including a long timeline to the implementation of said deal.

Elsewhere, risk appetite has been supported on two fronts since the beginning of the week – first by the China’s announcement of tax cuts and second by the reaction to this Brexit deal rejection. The FX implications have been somewhat minimal, with EM currencies and the Antipodeans supported on improvement in risk appetite, not just in equities but also in high yield spreads as junk bonds have been on a tear since the Fed pivoted to a more dovish stance. For the G3, EURUSD’s ambitions to the upside have been tempered by the meandering course that USDCNY has taken after the one off move lower and by the weight of EURGBP in the wake of last night’s rejection – more on that below.

Animal spirits and China’s policy intentions are in the driver’s seat here, with the technical lay of the land for the majors largely inconclusive and messy and market participants lacking conviction and awaiting further signaling. Further policy pronouncements from China are a prominent risk over the coming week or so on rumors of a plenum or other major meeting to set the policy course. But China’s economic data is difficult to interpret at this time of the year and will remain so until the March timeframe or later, due to the impending disruption of the Chinese New Year celebration.

Chart: EURGBP

EURGBP has punched below the 200-day moving average at time today, a level now more or less the mid-line of the multi-month trading range as the market takes a positive view on sterling despite May’s historic defeat late yesterday. There is plenty more range to trade to the downside if the market continues to unwind its defensive positioning on sterling on the underlying assumption that neither a Corbyn government or a no-deal Brexit are on the cards.