Currencies | Jan 16 2017
By Kathleen Brooks, Research Director, City Index
The FX market has spoken, and, as of Sunday night, it is not confident that Theresa May can deliver the necessary clarity and confidence when she lays out her Brexit plans in a speech on Tuesday. GBP/USD fell below the key psychological level of 1.20 at the start of play, suggesting that Theresa “pound slayer” May, could strike once again and we may see further declines in sterling this week.
The details of her speech are set include plans for the UK to leave the single market and the European Customs Union, which are a bit like kryptonite for pound bulls. The FX market has been incredibly sensitive to Brexit since the EU Referendum in June, but now that we have breached this level, where can we go from here?
Could May’s speech actually help GBP?
Tuesday’s speech in London could trigger a “material drop” in the value of the pound, according to one of the PM’s aides, but is the PM calling the market’s bluff? There is an outside chance that May’s speech, if it includes details on what will replace single market access, could actually benefit the pound next week, for three reasons.
Firstly, key Brexiteer, David Davies, has said that it is likely the government will push for a transitional deal to ensure that access to our European trade partners is not stymied during Brexit negotiations. Secondly, the weekend papers also featured comments from the European Union’s lead negotiator who voiced concern about shutting the UK’s financial system out of Europe because of the disruption this could cause to financial markets. Lastly, the City’s lobby group dropped its request for financial “passporting” rights at the end of last week, which suggests to us that they may believe that a better option is available down the line. Thus, Sunday’s breach of 1.20 could be a classic sell the rumour, buy the fact. However, Theresa May will need to give the speech of her life to reverse the wave of negative sentiment towards the pound right now.
Brexit certainty could prove to be the pound’s tonic
It will be an uphill battle for Theresa May to trigger a sustained pound rally this week, especially since Brexit has been a green light to sell sterling. Added to this, markets are once more reducing their long positions in sterling. According to the most recent CFTC data, net long positions in GBP/USD fell to -65.8k last week, vs. -64.7k the week prior. But, and it’s a big but, if she can deliver a level of candidness we have not come to expect from the UK government, this may be enough to slow GBP selling if she can deliver some level of certainty about what Brexit will look like and how the government will cushion any blow from leaving the single market.
GBP/USD on the precipice ahead of May’s speech
Late on Sunday, the market was not favouring the pound, suggesting that May’s foscus on immigration in favour of single market access has been viewed badly by the FX market. GBP/USD was flirting with the psychologically important 1.20 level, which could herald a move back to 1.1841 – the low from October’s flash crash (according to Bloomberg pricing). If Theresa May can’t instil market confidence on Tuesday then the second wave of GBP selling could trigger a move back towards 1.10 in GBP/USD, we would also expect heavy losses in GBP/JPY, and the pound’s recent recovery against the euro is also likely to reverse.
FTSE 100 a silver lining to pound weakness
Conversely, this could be good news for the FTSE 100, which has, so far, been immune to the bad news surrounding Brexit. and reached another record high on Friday. Even the FTSE 250 – which is a stronger reflection of the UK’s economy than the FTSE 100 – was also higher on Friday. This index has generally been tracking the FTSE 100 since December, suggesting that Brexit fears are not clouding investors’ view of the corporate Britain, at least not yet, anyway. We could see further FTSE 100 upside on Monday now that GBP/USD is below 1.20
Elsewhere, on the agenda…
This week we’ll mostly be talking about Burberry results on Wednesday, the ECB meeting on Thursday and, of course, Trump’s inauguration on Friday. May’s speech on Tuesday and her meetings with Chinese officials at Davos this week are also high on our agenda, as they could potentially move UK markets. But as the pound takes a dip at the start of this week, we believe Theresa May has a tough job to convince markets that she can manage a “clean and hard” Brexit, without doing long-term damage to the UK economy.
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