On the cusp of the most critical period for the UK in decades, the bets are stacking up against the pound. Theresa May’s arrival at an EU leaders’ summit in Salzburg today kicks off her battle to land a withdrawal deal and defend her Chequers agreement on our future relationship with Europe — as well as, possibly, ensure her own political survival.
But the blizzard of party conferences, summits and Parliamentary votes will be scrutinised just as intently by financial markets with fortunes hanging on the nature of the UK’s Brexit deal — if one can be struck.
The heightened rhetoric over a hard Brexit during the news lull of the summer has concentrated minds and shaken faith in sterling, despite a Bank of England rate rise last month.
According to figures from the Commodity Future Trading Commission, hedge funds and speculators have amassed a £4.4 billion short position against the pound, built steadily since May’s Chequers plan prompted a slew of ministerial resignations.
And the Bank of England has noted skewed pricing in the cost of so-called “risk reversals”, a common currency hedging strategy using put and call options which give traders the right to sell and buy at a certain price. The trouble is that in the current uncertainty, more people want to “put” — sell at a guaranteed price — than call.
Meanwhile in the gilt markets foreign investors offloaded a record £17.2 billion of gilts in a single month during July, brutally underlining the current nerves around holding sterling assets.
With the mood this febrile, it’s no wonder markets are on a hair-trigger. According to Panmure Gordon’s economist Simon French, sterling has seen three single-day 1% moves against the dollar in the past month. Although US jobs figures drove one such move, Brexit has been behind the others; notably reports Germany was prepared to soften its line on Brexit and words of encouragement from the EU lead negotiator, Michel Barnier, who said a withdrawal deal could be struck within eight weeks. “You get the suspicion that Barnier is a day trader in sterling,” says French glibly.
More negative noises, however, have come from Commission president Jean-Claude Juncker’s criticism of the key plank of Chequers — sticking close to the EU on goods but going our own way on services. May therefore certainly needs a good start in Austria this week. Speculation that Barnier could get a revised mandate from the EU 27 to do a deal has helped, and the fact that the pound has gently crept above $1.31 has helped too.
Nomura’s Jordan Rochester reckons this week’s summit could be the most significant moment of the autumn as “it tells us whether there is a landing zone for the UK” on getting a deal.
He adds: “The biggest risk has probably fallen away, of no deal, although in terms of hedging, we should probably have regard to it in the market.
“The biggest hurdle could be Salzburg if the UK doesn’t receive the good news it needs. If that happens next that opens up a whole new Pandora’s box of events.” If the EU kills off Chequers completely, it might kill off May too.
But when the summitry is over, then comes the party conference season. May’s “hard Brexit” speech in 2016 sent the pound to 30-year lows and last year’s disaster — collapsing stage sets, a hacking cough and a fake P45 to boot — also shook the currency.
THIS time round there’s every chance of more of the same as Theresa May takes to the podium on October 3, having to fend off big beasts like Boris Johnson on the fringe and tickle largely Eurosceptic activists. “Anything that opens the door to a general election is not going to be received well,” says CMC Markets analyst Michael Hewson.
Certainly there’s more chance of the Tories moving the market in Birmingham than the Labour party in Liverpool next week, unless the Opposition drops a political hand-grenade and comes out in favour of a “People’s Vote” on any deal, potentially stopping Brexit altogether.
“That could be materially positive for the pound, although there’s still only around a 5% chance of that happening,” says Rochester.
Assuming the PM gets past October’s EU Council summit, resolves the Irish border issue and gets a withdrawal agreement, prospects then look a little brighter for her — even if she only obtains a vague political declaration on the future trading relationship (the so-called “Blind Brexit”). A withdrawal deal at least guarantees a transition period to 2020, which should underpin the Bank of England’s hopes of a smooth and orderly exit and could even bring more rate rises into play: good news for the pound.
However, the Bank may still be in the dark about that by the time of its next meeting in November, before a potential leaders’ summit in mid-November to approve the withdrawal deal.
Capital Economics’ Ruth Gregory believes the “crunch point” could come in late November with Parliament’s “meaningful vote” on any deal, though her central case is that sterling recovers towards $1.40. But despite the huge uncertainty ahead, many pundits think the “big short” on sterling could be the wrong move. After all, the Brexit hardcore has enough support to get a vote of no confidence in May, but not to win it. Bringing down the Government, and a likely general election, certainly won’t appeal to Tories fearful of Corbyn.
Nomura is recommending its clients short the euro against sterling, while CMC’s Hewson recommends “buying sterling on the dips”. Trading this kind of market is fraught with danger, but Panmure’s French also reckons “sterling is oversold” and sees the logic in shorting FTSE companies whose shares have benefited from their foreign earnings — “the likes of Unilever and GlaxoSmithKline” — and would be hurt by the pound’s resurgence.
Bucking the market and backing the Buffett strategy — be brave when others are fearful — could be the way to trade a turbulent autumn, with a big bet on sterling. It might be a bumpy ride, though.
What the bookies say May still to be PM on April 1, 2019 8/11 EU deal; May survives until next election 7/4 No deal; May goes 4/1 No deal; May stays 8/1 General election in 2018 9/1 General election in 2019 7/4 Jeremy Corbyn PM by end of 2018 10/1