Morning Commentary: Brexit: The gift that keeps on giving

Foreign Exchange - Morning Commentary
Brexit: The gift that keeps on giving  
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Andrew Kositkun
Andrew Kositkun
Foreign Exchange Head Trader
Last week’s EU Council meeting was a natural deadline for the U.K. and the EU to either agree to the principles of a deal or agree to disagree and begin preparing for a no-deal exit. Instead, as has happened repeatedly over the past 4 years, clarity on Brexit has proven elusive. The markets are now faced with roughly 2-3 more weeks of negotiations and brinksmanship before we reach the end of the road and a deal or no-deal decision can no longer be delayed.

It is difficult to assess how much progress has been made on talks, but it appears that all the sticking points — fishing, state aid, etc. — remain the same. Based on comments from both sides, the only thing we know is that both sides are disappointed that the other side has not made sufficient concessions and that both sides claim to be willing to accept a no-deal exit. Granted, all of this is likely a negotiating tactic. Markets are still assuming that once we get close enough to the deadline, both sides will be forced to soften their stances and agree to a face-saving narrow deal. But of course this isn’t a certainty, and that is a concern from an economic and FX perspective with the British pound currently sitting around where you would expect it to be on a narrow deal (low 1.30s) rather than on a disruptive no-deal exit (low 1.20s or lower).

The asymmetry of where the spot rate is relative to potential levels of the two possible outcomes suggests a bias to be bearish the pound. In essence, there is more room to drop on a no-deal outcome than to rise on a narrow deal.

Of course, there are also currency negative issues outside of Brexit. The U.K. is currently facing a spike in COVID-19 cases that has required the government to reimpose lockdown restrictions, albeit at a regional level. Moreover, the U.K. economy suffered a worse negative first wave impact than the majority of countries. It was also slower to reopen, relative to other countries, which means the economy has made up less ground before being faced with the current possibility of renewed shutdowns.
  • U.S. stimulus talks continue with House Speaker Nancy Pelosi setting tomorrow as the deadline to agree on a stimulus plan that can be passed before the election. While President Trump has upped his proposed stimulus total, Senate Republicans remain opposed to a “bigger number” and will be voting on a skinner $500 billion proposal. The wide gap between Senate Republicans and the White House, let alone House Democrats, makes a deal unlikely. Further, Treasury Secretary Steven Mnuchin is in the Middle East this week, removing a key person in stimulus negotiations.
  • ECB officials sounded dovish over the weekend with ECB President Christine Lagarde warning that new virus restrictions will increase uncertainty and that the central bank stands ready to do more if needed.
  • Moody’s downgraded the U.K.’s credit rating to Aa3 with a stable outlook, but this had little impact on U.K. assets. Moody’s move aligns its rating with Fitch’s rating. Standard and Poor is currently reviewing its U.K. rating and is expected announce a downgrade this Friday.
  • Chinese economic data continues to support the recovery narrative. GDP missed market estimates (5.5%) but still rose 4.9% year-over-year. Additionally industrial production beat expectations as it rose 6.9% year-over-year against expectations for a 5.8% increase. 
  • New Zealand Prime Minister Jacinda Ardern and her Labour Party won an outright majority over the weekend with the biggest share of votes in over 70 years.
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