The FTSE 100 was a shade lower on Wednesday as the pound stabilised and we saw a broader risk-off move in European equities and overnight in across Asia.
For the blue chip index it seems it’s entirely a pound story. Sterling stabilised after a volatile day on Tuesday, and whilst risks remain fairly balanced, there are still sizeable risks on the downside. GBPUSD has found its feet around the 1.3100 level having recovered from the shock of the government defeat with the 1.30 handle now a fairly robust support level, with this constituting round number support and coinciding with rising trend support. The almost certain rejection of a no-deal exit tonight is on balance bullish for the pound, despite the uncertainty which persists. But whilst we remain short of the 1.33 handle, the late Feb highs, you would assume traders remain cautious.
Traders can expect more volatility ahead. The pound is in the near-term now set to be vulnerable to downside shocks as long as the impasse continues. The failure of the May deal raises the risks of a no-deal exit, in that the only deal on the table now firmly rejected by Parliament, twice.
Longer-term, however, the momentum is shifting in favour of a softer Brexit that Parliament can back, which could start a directional bullish trade in sterling. We could be at the start of this move now – but cannot ignore the short-term volatility and potential downside risks. This would require upheaval in UK politics – the emasculation of the executive, and a possible General Election to deliver a mandate for Brexit that works – possible near-term volatility but ultimately a positive for the pound.
Given the schedule of votes, it now seems that an extension of the deadline is assured. Parliament will firmly reject no-deal tonight and subsequently will be forced to ask the EU for a delay on Thursday. This will need to be a purposeful delay and the UK will need a ‘plan’ as to what it intends to do. Which leads us to Parliament taking over the process, and a likely General Election. This extension may well be longer than the short delay many anticipate, although European elections this spring make it troublesome and a snap poll and fresh Parliamentary mandate would be possible in a relatively short space of time. However, negotiations on a new deal would take longer. The 27 members will need to agree unanimously, but the idea of forcing Britain out without a deal should mean they agree on a delay.
This is all very messy – there is not clear and clean way out of this – leaving uncertainty and caution the order of the day for sterling and other UK assets. A General Election may not necessarily decide the matter, which could leave a second referendum the only ultimate route out. Again that would be bullish ultimately.
Looking at the GBPUSD price action, traders would be wise to stay cautious about near-term risks. However, Monday’s candle maybe significant. This bullish engulfing outside day reversal, indicating further gains for the pound, would be indicative of a longer term change in direction. If the UK crashes out without a deal this this would rendered moot, but if momentum turns towards a softer version of Brexit, we may see this bullish turn play out.