Pound Traders Give Thumbs Down to Johnson’s New Brexit Strategy

LONDON (Capital Markets in Africa) – The mandate for Boris Johnson’s Brexit strategy came from the ballot box. It is not winning a vote of approval in the global currencies market.

The pound slumped by the most since January after the prime minister announced plans to set a Brexit deadline of December 2020 with or without a trade deal between the U.K and the European Union. The renewed prospect of a disorderly withdrawal from the bloc erased all of the sterling’s gains since an exit poll predicted a clear majority for the Conservatives in last week’s vote.

The pressure on sterling deepened as the day wore on, providing a stark illustration of how investors perceive Johnson’s tough stance, compared with earlier hopes for reduced uncertainty over getting a Brexit bill through Parliament. Money markets also reversed course, with the probability of a Bank of England rate cut by next May back at 50%, or the same probability as before the election.

“Those who thought that a big majority would free the prime minister to take a patient approach to negotiate the best possible deal have been caught by surprise,” said Kit Juckes, a chief foreign-exchange strategist at Societe Generale SA. “And that’s most U.K. economists and strategists.”

For JPMorgan Chase & Co, the risk of a no-deal Brexit remains at an “uncomfortably high” 25% following the election win. One-year implied volatility on the pound-dollar pair was headed for the biggest jump since March.

The bank’s economist Allan Monks wrote in a research note dated Dec. 13 that while Johnson’s sturdy majority means “the indecision and domestic delays” of the past two years should be over, it also means the government is likely to take a forceful approach in the upcoming negotiations.

Getting Pounded
The pound hit a new day-low in the afternoon London trade, down 1.5% at $1.3132. It weakened by 1.4% against the euro. The FTSE 250, the U.K.’s domestically-skewed stock index, fell by as much as 1.7% with declines for banks and retailers. The FTSE 100, home to a range of multinationals that benefit from a weaker pound, slipped by a more modest 0.2%.

• U.K. government debt rallied, outperforming its European peers, with the yield on 10-year gilts down five basis points to 0.77%
• Sterling advanced to as high as $1.3514 on Friday, reached as an exit poll predicted the Conservative Party’s sweeping victory in the general election

EU leaders have warned it’s highly unlikely that negotiators will be able to complete the kind of deal Johnson wants — which he’s modeled on Canada’s agreement with the EU — in the 11 months between Brexit day Jan. 31 and the December deadline. This sets up a fresh cliff-edge for a no-deal split with the EU at the end of 2020.

“It is fitting that the main culprit for the reversal is PM Johnson himself with his potentially ill-advised decision to block any chance of extending the transition period beyond December 2020,” said Valentin Marinov, head of Group-of-10 currency strategy at Credit Agricole SA.

Market Vigilantes
The pound has been the main vehicle for investors to express their view on Brexit negotiations throughout the process. In October 2016, the pound declined almost 6% as investors expressed dismay at suggestions the government was headed for a so-called hard Brexit and the same dynamic played out this year as the market reacted to the prospect of a snap election and a looming October Brexit deadline.

There’s a long history of speculators forcing governments to change tack, from the famed bond vigilantes to the move by speculators including George Soros in a previous battle over Britain’s relationship with Europe.

The U.K. election campaign saw a dramatic shift in sentiment toward the U.K. currency, which may be tested by the new government’s Brexit strategy. A Citigroup Inc. index indicates that currency funds have almost completely unwound their bearish bets on sterling. Asset managers have also switched to a net long position in the pound from a net short before the vote, data from the Commodity Futures Trading Commission showed.

For Credit Agricole’s Marinov, it would take a bigger move to impact the political process. “I was a bit surprised, to be honest by the aggressiveness of the drop in the pound given that a lot of what has happened is posturing before the start of the trade negotiations,” he said. “The moves in FX, as well as other markets, have to turn even uglier to have a more meaningful impact on the decision-making process in Westminster.”

Source: Bloomberg Business News