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Ready to trade? (Market Analysis)

Financial events

<h2><strong>FX:</strong></h2>
<p>GBP/USD has been firm since Sunday’s decision to extend talks, rallying off its 200-day SMA from 1.32 up to an intraday high of 1.355 today. This is due to news of movement on the very thorny issue of the Level Playing Field. However, fishing still remains problematic with neither side wanting to give any ground. Most market participants believe a deal will eventually be sealed, even it means going right to the wire. The bookmakers have flipped back to now seeing a deal as the most likely outcome with popular political betting site Smarkets most recent odds showing an 82% probability a deal is completed before year end. </p>
<p>London has now entered Tier 3 restrictions, which will place the hospitality sector under further pressure. This swift decision came about as a result of a new variant of the coronavirus spreading rapidly in southern England. However, the UK Health Minister stated that it was highly unlikely it wouldn’t respond to the vaccine. The first mover advantage on the vaccine and return to normality is one of the key positives for Sterling. </p>
<p>Long cable trades are exposed to an asymmetric risk reward profile in that upside is fairly limited to around the 1.35/1.37 level with a thin-trade deal whereas on a no-deal scenario, cable could fall to 1.25/1.20 with sub 1.20 not out the realm of possibility. Positioning data is flat and at these price levels the Brexit risk premium is very small, hence shorts could accumulate rapidly. Shorts would be much better expressed through GBP/USD as the euro would undoubtedly also suffer on a no-deal outcome. </p>
<p>Implied vols have pared back slightly from Sunday, but are still elevated on the whole. 25 Delta Risk Reversals on the 1-week and 1-month tenure are both substantial at -3.25 and -3.5 respectively. <br>
<br>
We have the BoE’s monetary policy decision tomorrow. I don’t expect any changes at this meeting especially with Brexit uncertainty - the bank will be keeping its powder dry and retaining maximum policy flexibility. Given the BoE already acted in November to increase its QE programme, Governor Bailey won’t feel under pressure to act. I’ll be keeping my eye out on any further rhetoric regarding negative rates. Interestingly, recently there has been pushback from some of the big banks such as HSBC and Santander on negative rates. With Santander stating systems would need 12 – 18 months of preparation in order to implement this. Additionally, HSBC pointed to the poor results of its implementation in places like Europe, Switzerland and Japan. If negative rates are decisively taken off the table then Sterling could get a much needed tailwind. </p><p><img data-image="4cn59st4jora" src="https://eu-images.contentstack.com/v3/assets/bltaec35894448c7261/bltafdb6080ce5bfa64/5fda3d0a71c2890804275a95/GBPUSD[1242].png" data-sys-asset-uid="bltafdb6080ce5bfa64" alt="GBPUSD[1242].png"></p>
<p><br>GBP/USD’s technicals look solid. Price has formed an ascending triangle pattern – typically bullish. The 50-day SMA (yellow line) is still pointing upwards and above the 200-day SMA (pink line), however, the upper band of the Bollinger Bands do seem to be restraining price. 1.355 definitely is a resistance level which needs to be cleared should GBP/USD advance towards 1.37. It does look like price needs to take a breather after rallying strongly the past 3 days. However, a surprise trade deal announcement could cause a sharp pop in the price up towards 1.37.</p><h2><strong>Gold</strong>: </h2>
<p>Gold has been a solid place to park your cash this year given how low rates have been. However, looking at the price action gold has been in a gentle downtrend since its August peak of just over $2000, forming a descending triangle pattern which usually breaks to the downside. There is important support at $1830 which if broken could see a slide to the November lows of $1770. Price seems stuck in a tight range between the 50-day and 200-day SMAs. Positive vaccine news has worked against the yellow metal and clearly seen appetite for riskier assets increase with the result being a rotation out of gold. However, increasing inflation expectations and further fiscal stimulus packages should be supportive for gold going forward. A weaker dollar will aid in this regard and ultra-loose monetary policy should keep real yields negative - lowering the opportunity cost of holding gold. ETF demand has been a key driver behind gold’s rise this year. Physical demand from consumers in emerging markets like India and China has been weak due to having to prioritize their cash flow and spending habits. However, as normality returns there should be a decent bid from this demographic as gold jewelry is a popular choice for gifts during the marriage and festival season. </p><strong><p><img data-image="co3n0gjomt43" src="https://eu-images.contentstack.com/v3/assets/bltaec35894448c7261/blt020c204268f4c0bc/5fda3d79574198696de23c0e/Gold[1244].png" data-sys-asset-uid="blt020c204268f4c0bc" alt="Gold[1244].png"></p></strong><h2><strong><strong><u><br></u></strong>S&P 500: </strong></h2>
<p>The market has moved into risk-on mode with Congress on the brink of passing a $900 billion stimulus bill. Evidently there is a lot of optimism now baked into equity markets with 90% of S&P 500 constituents trading above their 200 DMA and BofA’s most recent fund manager survey shows that portfolio cash levels have fallen to 4%. The last real market moving event for this year takes place tonight as the Fed delivers their final monetary policy decision for 2020. Market’s aren’t expecting any major policy changes and any operation twist if it does happen will be pushed back to 2021. The Fed will provide clear communication to the market on their asset purchases going forward and will try to jawbone rates and the greenback lower to keep financial conditions as loose as possible. I expect more rhetoric around the need for timely fiscal stimulus. The other major event which should be on traders’ radars is the Georgia Senate run off races on the 5<sup>th</sup> of January. This has the potential to cause substantial volatility should Democrats pull off a shock victory and take all chambers of congress. This would have huge implications for financial markets, especially the dollar, equity markets and rates. Although this is not seen as the probable outcome, it certainly is not outside the realm of possibility. PredictIt has Democrats’ odds at 34%. </p><p><img data-image="5f1usaooik2g" src="https://eu-images.contentstack.com/v3/assets/bltaec35894448c7261/blt1c48e1e18ba529da/5fda3dd9080cae071913b66a/SP500[1243].png" data-sys-asset-uid="blt1c48e1e18ba529da" alt="SP500[1243].png"></p>

GBPUSD[1242].png

Could markets throw up some surprises before Santa arrives?

<p>To put some of this into context, cable fell 4.8% after the Brexit referendum in June 2016 whilst it rose 6.8% last week, after falls of over 5% in each of the previous two weeks. It seems the dollar has moved faster and deeper relative to its ascent than other risk appetite measures and GBP has whipsawed with it.</p>
<h3>Dollar funding pressures</h3>
<p>The well-known ‘dash for cash’ period we experienced for a couple of weeks ago saw the pound collapse to its lowest level on record against the currencies of the UK’s major trading partners. Sterling’s broad effective exchange rate was weaker than at any time during the Brexit process, the GFC and even the UK’s ejection from the European Exchange Rate Mechanism in 1992. Funding pressures took hold of currency markets as extremely poor levels of liquidity saw a surge in demand for USDs.</p>
<h3>3 reasons for a pounding</h3>
<p>It is important to briefly run through a few broader issues which hurt GBP initially and may do so going forward. Firstly, the elevated UK current account deficit means sterling will be exposed when there is a liquidity crunch. The UK has ongoing funding needs, and this is especially the case when the UK ranks last amongst all the other G10 countries in the size of its deficit.</p>
<p>Secondly, valuation remains an issue. If GBP traded only on the basis of yield spreads compared to the US and Germany, its fair value would be much higher, above 1.30. However, in today’s environment, we have still not seen extremely weak valuations, with the lows last week not being more than one and a half standard deviations versus the undervaluation for the other majors.</p>
<p>Finally, Brexit issues still do matter as the pound has suffered a structural decline with the Government’s inflexible position hampering its currency. This is likely to remain a constant background negative noise for GBP going forward. The timeframe for reaching a comprehensive deal looked tight even before the virus outbreak so an agreement looks highly unlikely, with the risk of a no trade deal Brexit denting the scale of GBP’s upside. Of course, a change of heart from the government would change this scenario.</p>
<h3>Near-term global trends</h3>
<p>GBP will be dominated by what is happening with risk sentiment in the short term. The latest Fed gesture has caused a decline of the dollar and with it an aggressive unwinding of sterling shorts. With sterling volatility remaining near the levels last seen since the referendum, and given the risk-averse mood in markets, we should expect choppy two-way trading to continue. Record prints in US jobless numbers will no doubt impact as well in cable. 1.2550/80 is the next resistance zone, before a confluence of indicators just below 1.27. Support comes in at the 50% retracement level from the recent high to below 1.15 at 1.2308 which sits just above the 21-day moving average.</p>
<h3>Technical long-term low?</h3>
<p>With cable hitting 30-year lows last week, the impressive rebound does potentially look quite constructive further out. The monthly close will be significant as a bullish hammer candle may act as a basis for confirmation that a major bottom is in place.</p>


sterling.jpg

Where next for the sterling rollercoaster?

<p>The EU agreed its mandate for talks on its future relationship with the UK on Tuesday and Boris Johnson sets out his today. The ‘red lines’ for negotiations are now ready for the commencement of the official talks of <a href="/market-analysis/uk-data-deluge-points-to-steadiness-in-the-economy">Brexit round two</a>, which open in Brussels next Monday.</p>
<p>Like all negotiating mandates, we need to bear in mind both now, and throughout the next potentially tortuous phase, that the documents represent an opening bid which experienced negotiators know will be whittled down through the necessary compromises that lead to a deal.</p>
<p>As an initial example, the EU’s set of principles signed off on Tuesday are at odds with statements made by Boris Johnson and David Frost, the chief UK negotiator, about the UK’s desire to fully ‘take back control’ on January 1. In previous weeks, in his first major speech, Frost outlined the first major red line as he dismissed signing up to a ‘level playing field’ setting common rules and standards, to prevent businesses in the UK undercutting those on the continent in the bloc.</p>
<h3>A tough road ahead</h3>
<p>Regarding other specific trade agreement objectives, the most important red lines for the EU also concern protecting the integrity of the single market and customs union, and securing fishing rights in British waters. For the UK, those lines include an end to regulatory alignment and the jurisdiction of the EU court.</p>
<p>Of course, both sides have stated that the ambition is to strike a comprehensive trade deal before the deadline on 31 December 2020. PM Johnson has refused to extend this transition period (for now) which means in reality, the UK and EU will have to prioritise the most urgent issues. He’s also said he would rather walk away from negotiations and trade on WTO terms from the start of next year, than sign a deal where the UK becomes a rule taker and falls under the jurisdiction of the EU Court. From their side, the EU have expressed very clearly that the deadline of July1 for extending the transition is inflexible.</p>
<h3>How deep is the red?</h3>
<p>PM Johnson has enshrined in law the 31 December deadline which suggests that ultimately, the UK government may concede in some areas, in order to get a deal done in some form this year. With his healthy, recently gained Parliamentary majority, perhaps the PM has some flexibility too in making some concessions, as he won’t have to face voters again until 2024.</p>
<p>On the flip side, walking away from these talks may not be as significant as in previous Brexit negotiations, simply because the differences between a free-trade agreement and no agreement may not be as big as some headlines make out. That agreement doesn’t mean frictionless trade, as the white tape involved means it is easier to pay tariffs. So, will PM Johnson come to the conclusion that doing that is the price worth paying for ‘taking back control’?</p>
<h3>Sterling effect</h3>
<p>It seems slightly too self-fulfilling that more GBP weakness is on the cards through the second quarter as investors become increasingly impatient with the lack of progress. Elevated Brexit uncertainty will also weigh on business investment, which may bring the Bank of England into play with a rate cut in late Spring.</p>
<p>The more GBPUSD trades in a range – between 1.2850 and 1.3050 near-term, and 1.28 and 1.32 longer-term (since mid-October) – the stronger the breakout will be. With waning upward momentum currently, could the pound be in the early stages of a new correction phase?</p>
<img src="https://files.pepperstone.com/27_02_2020_Brexit.png?mtime=20200227102239" alt="2020 brexit timeline chart" width="" height="" data-image="rgbvpkr9stai">

get-ready-for-brexit.jpg

Get ready for Brexit phase two

<h2>Robust labour market</h2>
<p>Tuesday saw wage growth dip to 3.2% excluding bonuses at the end of 2019, down from almost 4% last summer and the slowest rate in over a year. However, the slowdown was in line with the BoE’s expectations set out in November’s MPR and there will be a timely boost to real wage growth in April when energy bills for households are set to fall noticeably.</p>
<p>The labour market remained largely buoyant in the face of Brexit and electoral risks, and certainly better than surveys had been suggesting. The employment rate rose to an all-time record high, while the unemployment rate remained unchanged at a near-record low, which should continue to reaffirm that the UK labour market remains tight. The key question now is whether this resilience and improving December surveys translate into more positive figures going forward, with the ongoing uncertainty over the future UK-EU relationship.</p>
<h2>Inflation to fall in the months ahead</h2>
<p>Similarly, inflation appears to be evolving in line with the BoE projections. The headline rise was primarily due to base effects of higher petrol prices and air fares, and this should fall back through the Spring as declining household energy costs trickle through.</p>
<p>Inflation has remained below the BoE’s target since last August, resulting in market speculation that the bank would need to act if price pressures eased further in the coming months. But for now, the decision to keep rates on hold is vindicated by the latest reading, with currently a 27% chance of a rate cut at its May meeting.</p>
<p>The latter part of the week has also seen markets shrug off a beat in retail sales which points to a rebound in UK household spending after the election risk late last year. This will be a welcome relief to the more hawkish elements on the MPC who supported holding off on easing until there was more clarity. Along with today’s improving manufacturing PMI, albeit with a mild drop in the services sector, IHS Markit still forecast UK Q1 GDP at 0.2%.</p>
<h2>Sterling ahead</h2>
<p>Moving forward, GBP will be driven by fiscal tailwinds and Brexit headwinds, with improving sentiment from the election helping to keep the economy ticking along. A steeper gilts curve suggests markets are prepping for generous fiscal support from Boris’ budget (sorry, new Chancellor’s Rishi’s plan) on March 11. So, policymakers will be looking for any signs that rising business sentiment is translating into faster economic growth.</p>
<p>But further out, any short-term boost to sterling post-budget may not sit well with a retrenchment in risk appetite and the inevitable Brexit negotiations. These are growing increasingly tense as both sides set out their red lines, in classic ‘first round’ negotiation tactics. Surely the market will blink first as the clock ticks closer to the June 30 deadline to extend the transition period?</p>
<p>1.30 had been acting as a magnet over the last week or so in cable, until it moved lower on dollar strength and below both the 50 and 100-day moving averages. We are now attempting to rebound from the bottom of the 1.28-1.30 range with support at 1.2830/50 and resistance above at 1.2950.</p>


london-city.jpg

UK data deluge points to steadiness in the economy

<h2>Dovish cocktail feeds rate cut hopes</h2>
<p>Rate cut expectations soared at the beginning of the year as Carney himself kicked off an avalanche of dovish MPC speak and weak economic data from the fourth quarter of last year. Figures showing the economy shrank in November and retail sales unexpectedly falling in December look to have sealed a move lower in rates as the chances of a 25bp move at its January meeting spiked from 5% to 72%. Notably, headline inflation came in at a three-year low at 1.3%, well short of the BoE’s 2% target, while the core measure nosedived to its lowest level since October 2016. Moreover, in contrast to 2018 when inflation also undershot its target, it appeared the BoE was not worried about a weaker sterling at this point.</p>
<h2>‘Boris bounce’</h2>
<p>All eyes moved to last week’s PMI data, which has since cooled expectations for a rate cut. The services index, accounting for around 80% of overall UK GDP, leapt to a sixteen-month high in January, while manufacturing moved sharply higher, even though it remains below 50 that denotes contraction. Recent jobs and wage growth data have also pointed to a relatively healthy labour market.</p>
<p>Of course, Brexit finally takes place on Friday so does this symbolic date dictate that the BoE hold off from any action due to the political signal it would send out? More importantly, we think the BoE does not yet know the full impact of the possible post-election rebound.</p>
<h2>Heads or tails?</h2>
<p>According to Saunders, one of the MPC members who voted for a rate cut at the last meeting, it would be wise to move swiftly and aggressively with a rate cut. The cost of waiting could be high; indeed, some analysts are calling for an ‘insurance’ cut – one and done – until the inevitable deliberations over the next Brexit stage and deadlines begin.</p>
<p>As we have written previously, we don’t think there is enough data to push the BoE into action. The MPC may also be watching the March 11 budget with some interest, ahead of the start of the new Governor Bailey’s term.</p>
<h2>Market reaction</h2>
<p>The front end is currently pricing around 12bps in cuts for this meeting, with a full 25bp cut priced around June. Profit taking in the short sterling curve has seen some push back since last week’s extreme pricing. GBP has been relatively steady, holding around 1.30, even as market pricing for a January cut have risen from effectively zero to 50% or so.</p>
<p>A sell-off in sterling seems inevitable in the event of a cut, but guidance will be crucial in determining whether this is a one-off move and not part of a sustained easing cycle. A convincing break of 1.2954 and then 1.2905 which act as firm support, may see a return to the October-December 1.28-1.30 range. Resistance stands at 1.3172 and 1.3284 above.</p>

bank-of-england.jpg

To cut or not to cut?

<p>The release didn’t disappoint as all data showed the strongest evidence yet of a post-election boost to the economy. The composite PMI, which combines manufacturing and services, rose to 52.4 from 49.3, the highest reading since September 2018 and beating the 50.6 consensus forecast. The reading for British factories was also better than expected, rising to 49.8 from 47.5, the highest level since April last year, while the vast services sector returned to growth in January for the first time since August.</p>
<h2>Decisions, decision for the BoE…</h2>
<p>These flash reports for the new year are an important input for policymakers, ahead of next week’s BoE interest rate announcement. Evidence from other published surveys had also suggested a post-election recovery in both the services and manufacturing sectors, while leading indicators, like the CFO survey have indicated we would see a decent PMI rebound.</p>
<p>A key consideration for the Bank of England has been to what extent the weakness in UK economic activity last year was a result of elevated uncertainty, both domestic and international, which may be starting to subside now after the election and potential Boris-bounce.</p>
<p>The strength of the forward-looking components, with new orders showing the sharpest rise since September 2018, has now pushed this data point closer to neutral policy territory for the MPC. The composite PMI is also now well above levels usually seen when the bank has eased rates in the past. That said, one set of figures isn’t a trend and the manufacturing figures still signalled the ninth month of contraction.</p>
<h2>Flip a coin for a cut next week?</h2>
<p>Based on market prices, expectations for a BoE rate cut to 0.5% next week have eased back from 70% last week to around 50%, helped by firmer labour data. We wrote recently how we viewed this jump in odds as premature and think the BoE’s decision may be based more on in-house agent’s talk with businesses instead, as Governor Carney has suggested. Do the MPC keep their powder dry and reassess with a new Governor when GDP data for the post-election period in January is available? Money markets still see a high possibility for a cut in March.</p>
<h2>Choppy pound</h2>
<p>Sterling spiked to three-month highs on the initial headlines but has surrendered those gains in choppy trading. It seems profit-taking is the name of the game here as traders de-risk ahead of next week’s meeting. Dovish signals are still expected from the bank which means further near-term gains in sterling may be capped.</p>

london-eye.jpg

UK PMIs point to an encouraging start in 2020

<p>Considering Parliament returns from its current break on 3 September, this leaves an incredibly short period for those who oppose a no-deal Brexit (i.e., the Remainers) to make some big moves before Parliament is suspended on 12 September. <strong>GBP volatility could therefore be elevated through the period of 3 - 12 September given the prevailing uncertainty.</strong> Clearly, GBP will also be moved by headlines.</p>
<p>Ultimately, the Remainers have three options to pursue from 3 September:</p>
<ul><li><strong>Try and pass legislation through the House of Commons</strong>, which will involve extending Article 50 in the hope of a new deal with the European Union</li><li><strong>Hold a no-confidence vote in the Johnson Government </strong>either in the 3 - 12 September window or after the EU summit (17 - 18 October)</li><li><strong>Accelerate the Scottish legal challenge</strong>, with Scottish judges ordering Johnson to revoke A50 on the grounds that suspending Parliament is unlawful</li></ul>
<p><strong>A deal to be found? 25% (based on my gut instinct model)</strong></p>
<p>If a legal challenge arises and amplifies the risk of extending Article 50, with increased discussion on the withdrawal agreement at the EU summit, one’d then imagine the GBP having a rally above 1.2300. We’ve already seen a softening in the language and a more constructive dialogue that played out in recent meetings between French President Emmanuel Macron, German Chancellor Angela Merkel, and Johnson — a contributing factor to GBPUSD rallying 1% last week. Still, the timeline is tight, and actually finding a solution that passes a fragmented Parliament is still the concern.</p>
<p>As we can see from the Commitment of Traders report (GBP futures non-commercial holdings), the market is still holding a decent short exposure.</p>
<img src="https://files.pepperstone.com/aug-30-brexit-01.png?mtime=20190830164234" alt="Huge period ahead of Brexit" width="" height="" data-image="q5rpxm6m5rle">
<p>Two-month risk reversals show a market paying up for put vol over call vol, while liquidity in GBP pairs is somewhat lacking, which we see that in bid / ask spreads and poor liquidity could exacerbate moves.</p>
<img src="https://files.pepperstone.com/aug-30-brexit-02.png?mtime=20190830164624" alt="Huge period ahead of Brexit" width="" height="" data-image="24d5pxjwqqbp">
<p>One for the optimists. I think there’s a 25% chance of playing out — a low call however. But Johnson has limited interest in this outcome, and he’s driving the show.</p>
<p><strong>A general election? 45%</strong></p>
<p>Route two is looking very likely, if not inevitable, as in theory it’s the easiest avenue for Remainers to bring down the Government. With the Tories holding a narrow one-seat majority in the House, Boris will likely lose the vote with at least two rebels voting against the Government, and the Government will fail. In this scenario there’d be a 14-day period to find a caretaker government, like we saw in 1940. A national unity government would be required to manage the Brexit process.</p>
<p>The makeup of any temporary government is a huge question. The Remainers won’t want to be led by Johnson, but it’s hard to see any Tories wanting to work in a crossparty unity government led by Opposition Leader Jeremy Corbyn of the Labour Party. So, in the absence of a caretaker government being found within 14 days, it leads us to a snap general election framed as the “People versus Parliament.” I see this as a 40% probability, and is the current base case.</p>
<p>A general election would likely take place in November, or six weeks from when it’s called, and may require a short extension to A50 likely granted by the EU. This outcome would be naturally binary and a massive risk to traders, where GBP vols will be incredibly high on that date as it’ll be framed as “in or out,” or a new quasi-referendum on Brexit. It’s an event where I almost don’t see how the GBP does anything but fall. With a Johnson win, which seems likely if the polls are to be believed, the process of leaving the EU would accelerate (a GBP negative).</p>
<p>We may, of course, see a hung parliament. Alternatively, Corbyn gets up, and the odds of staying in the EU increase markedly. But we’ll be left with a hard-left politician running the country (a strong GBP negative). He may need a coalition partner, however, potentially in the form of Liberal Democrats.</p>
<p><strong>No-deal Brexit? 30%</strong></p>
<p>I won't cover option three. But consider if neither one nor two is enacted by 12 September, then the chance of a no-deal Brexit ramps up markedly, although it’s unclear if a no-confidence vote would be pulled in the 3 - 12 September window or post the EU summit.</p>
<p>With Johnson suspending Parliament from 12 September to 14 October, we resume proceedings 14 October with almost no time to get a deal in place for the Brexit deadline of 31 October. With such little time we could crash out almost by accident with no real plan in place to manage the fallout (look up for “Operation Yellowhammer” on Google). I see this currently at 30%. But if we don’t see outcome one or two play out before 12 September, then this outcome will become a base case, and GBPUSD will be less than 1.18 even if this outcome is partly priced given the steep falls in the GBP since Johnson became PM.</p>

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Huge period ahead of Brexit

<p>The market had thoroughly expected this outcome and had May’s departure fully priced, with GBPUSD having fallen from 1.3185 on the sixth of May into 1.2606. In fact, through this period, GBP fell against all G10 currencies with the most significant move seen against the safe-haven CHF and JPY, where there were literally no buyers. All intra-day rallies were contained into the 5-day EMA, and when price broke through the prior day’s low, it just attracted new sellers to the mix – hence the strong downtrend. The fact, then, that we saw GBP buyers on the news of May’s resignation reeked of a classic ‘sell the rumour, buy the fact’, with GBPUSD building on the break of 1.2700 on the re-open of trade today.</p>
<h6>GBPCHF Daily Chart</h6>
<img src="https://files.pepperstone.com/trading-ops-brexit-20190527-1.png?mtime=20190527151225" alt="GBPCHF Daily Chart, 14 Nov 2018 - 27 May 2019" width="" height="" data-image="tid1g22qhu60">
<p>In the short-term, the pair is eyeing a possible move into area 1.2800/30, which is where I would expect the short covering to abate and the sellers to initiate shorts again.</p>
<h2>GBP positioning and sentiment</h2>
<p>From a positioning perspective, the speculative FX community increased its net short GBPUSD futures exposures last week to -26,152 contracts – see the Bloomberg histogram below. Consider that while we saw a sizeable increase in GBP shorts on the week, current positioning is hardly at levels that can be considered ‘stretched’ or at extremes. We can also look at options market and eye one-month risk reversals, which portray the skew in demand for GBPUSD ‘put’ and ‘call’ volatility, to get a sense of where traders see the higher probability of a directional move over this period. Here, we see the skew at -0.1675x, which shows traders almost see symmetrical risk over this period, with the cost of putting on bearish options positions almost the same as bullish ones.</p>
<img src="https://files.pepperstone.com/trading-ops-brexit-20190527-2.png?mtime=20190527151400" alt="GBPUSD speculator positioning" width="" height="" data-image="spfmx7gocuwy">
<p>We can also see GBPUSD one-month implied volatility (IV) sitting off recent lows at 7.46%, which gives an implied move (up or down) from current spot levels of 227-pips. This gives us an expected trading range of 1.2953 to 1.2499. This hardly suggests the market fears fireworks ahead and consider this is half of IV we saw in March. With the market now staring at a challenge for the Conservative Party leadership, one questions if the market is too complacent or whether it is just a touch too early in the market’s thought process.</p>
<img src="https://files.pepperstone.com/trading-ops-brexit-20190527-3.png?mtime=20190527151442" alt="implied range" width="" height="" data-image="jbe266ck1i9o">
<h2>The process from here - choosing a new leader</h2>
<p>I’d argue the process started at least a month ago, with the various runners and riders seeing Theresa May’s position as Prime Minister (PM) as untenable and her time slipping by the day. Not only have MP’s been considering if they would run, but also, it has given MPs a chance to consider who they would vote for and strategically how it would influence their own careers.</p>
<p>There is now a two-stage process, which commences on the 10<sup>th</sup>of June, with the 313 Conservative members asked to hold a series of knock-out votes, taking place at least twice a week. The candidates are subsequently whittled down until the two remaining candidates go into a final run-off vote to the full Conservative Party of some 120,000 members. This vote should play out before September, which doesn’t give the incoming PM a lot of time until the <strong>Conservative Party Conference </strong>(29 September), the<strong>EU Council meeting </strong>(17 October), and ultimately the extended <strong>Brexit deadline</strong>of 31 October.</p>
<h2>The key players</h2>
<p>There are some 25 candidates who have put themselves forward for the role as PM, but we should focus on five standouts.</p>
<ul><li><strong>Boris Johnson</strong>- The former Foreign Secretary and the clear favourite. His charisma and sheer celebrity status may help in any future general election, and Labour fears him as a leader above all others. Johnson seems happy to engage all factions of the Tory party but is not averse to pushing without a deal and onto WTO terms if it’s the only option. In theory, Johnson as PM is a GBP negative, but is it mostly priced in?</li></ul>
<ul><li><strong>Dominic Raab</strong>– Knows the EU well having been Theresa May’s former Brexit Secretary. Seen as the most ‘no deal’ Brexit candidate in this list, which will appeal to the European Research Group (ERG). He will find it harder to garner support from the moderates, and certainly Labour, should a re-worked Brexit solution need to be put to the Commons. Raab as PM is a GBP negative</li></ul>
<ul><li><strong>Michael Gove</strong>- The Environment Secretary and an under-priced contender. An astute operator, who will appeal to both the Brexiters and the remain factions of the Tory Party. One to watch, especially given his history with Boris Johnson in the 2016 election. A small GBP positive given he has previously voted for May’s Brexit Withdrawal Agreement.</li></ul>
<ul><li><strong>Jeremy Hunt</strong>– The Foreign Secretary, but made his name as the former Health Secretary. According to <em>conservativehome.com</em>, has already picked up a strong following of Tory MPs, but is the most ‘remain’ leaning candidate here. Although, he has given hints at warming to a ‘no deal’. A small GBP positive.</li></ul>
<ul><li><strong>Sajid Javid</strong>– The Home Secretary. Supported remain in 2016, but has recently suggested a no deal Brexit would not harm Britain, which likely won him support from the ERG party.</li></ul>
<h2>How to trade this process:</h2>
<p>The overriding consideration has to be the 31<sup>st</sup>of October Brexit deadline, where at its most simplistic, GBP trades on the notion that the new PM will need more time to rally the troops and work a compromise. So, either a deadline extension is granted through to, say, March. Or, given the EU have already made it clear they won’t alter the continuous Irish backstop (despite a change of leader), the UK parliament is subsequently unable to find a compromise and hit the October deadline without a deal – a scenario we know the majority of the Commons are against, with the passing of the Cooper Amendment in April. However, should it happen, it will see GBP volatility rise significantly.</p>
<p>While the new PM may be a far more efficient negotiator than Theresa May and find ways of reaching compromise among the various party divisions, even across-party, unless the Commons agree on a deal that will ironically most probably look a lot like the three deals May already put to parliament. Then the only reason why the EU allows an extension is because of a political event – that being, either a General Election or a second referendum, which would contain ‘no deal’ or ‘no Brexit’ on the ballot paper.</p>
<p>With the current awful polling of the Tory party, a general election would create huge uncertainties, where the threat of a Corbyn led government sending the GBP heading toward 1.15, perhaps even lower.</p>
<p>MP’s have to think very carefully, not just about who would best unite a fractured Tory party, but also who would be best at going toe-to-toe with both Jeremy Corbyn and Nigel Farage, who will likely see his newly established Brexit party gain its first Commons seat in the Peterborough by-election on the 6<sup>th</sup>of June.</p>
<p>At this juncture, most roads are leading to a lower GBP, with the preference to sell further short covering in the GBP.</p>
<p></p>

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The race for PM and the new Brexit script