Brexit stakes have risen for both EUR and GBP

The Brexit deal struck between UK Prime Minister May’s negotiating team and its European Union counterpart is more than clearly dead on arrival and will not clear the hurdle for passage in a parliamentary vote as currently formulated. But what this means for the path from here is far from clear.

Conspiracy theorists would have us believe that May’s team did the best it could with the obstinate EU and was willing to agree to something that they would take back to the UK and show to the EU that it wouldn’t fly. This could then provide some leverage for shifting the EU’s position on key issues to get a better deal through as we barrel toward the March 29 Brexit deadline. Cabinet resignations could be part of an effort at adding “theatre”.

The flip side conspiracy theory is that the EU is hoping (I would argue with bottomless hubris if so) to stand as firmly as possible in hopes that the UK will be disciplined into changing its mind and making “the right choice” via a second referendum, believing that it has the upper hand and the UK would never take the leap into the unknown.

Of course, both theories could be true to a greater or lesser degree and let’s not underestimate how a crisis can motivate further action and change the plot quickly in coming weeks. Also, let’s make no mistake that the EU is playing with fire here – a no-deal Brexit is not only very immediately disruptive for the UK economy, it would likely also throw the slowing mainland EU economy into recession – just ahead of EU parliamentary elections next May. High stakes, anyone?

Alternatively, we can attempt to take the situation at face value and merely ponder whether this will eventually mean a stumble toward a no-Brexit and the path that stumble would take: first a May exit and either a new election or a second referendum or both? Sterling has been sold steadily, but a 2% move is hardly indicative of the potential here and I think the “controlled weakness” with sharply higher implied volatility in the options market is an accurate reflection of the possible paths from here.

I still don’t have any idea how this will turn out, but have a hard time believing that the UK ends up on a path toward “opting in” to the EU again, just as I have a hard time believing that anything resembling this deal will make it through parliament because as Iain Duncan Smith aptly states “Theresa May’s Brexit plan concedes our sovereignty in a way even worse than if we stayed in the EU”.

The Brexit summit is set for November 25 and is the next event risk if May does not resign or is not ousted in the interim. An article from Politico takes a stab at looking how things may develop in the days ahead.

Elsewhere, the market is trying to put an optimistic face for the upcoming Xi-Trump summit at the G20 in Argentina. I am reluctant to trust any noise or signals from the Trump administration or certain Twitter accounts until we have a look at how the meeting goes down. Some sort of truce or détente may be possible here and could yet generate a flurry of excitement and risk-on sigh of relief. But longer term the die is cast as the two great powers will inevitably find themselves at odds with one other. We may not even see any notable breakthrough emerging from Buenos Aires. Trump’s only motivation to make friendly is his apparent barometer of his popularity – the stock market.

Chart: EURJPY

The JPY doesn’t know what to do here – it has risen versus EUR and GBP as the market has discounted those currencies on Brexit woes, but offsetting that has been an improvement in risk appetite on hopes that a US-China trade détente is on its way in a couple of weeks. Still, EURJPY trades heavily and a view lower encapsulates multiple angles on the FX market here: the risk of a hard Brexit, the re-aggravation of the Italy budget showdown and possibly even the US-China relationship souring again.

The technicals aren’t particularly compelling but it has broken down below the daily and weekly Ichimoku clouds and a break below 125.00 could set something larger scale in motion to the downside in coming weeks.