After the June 2016 Brexit vote the British pound (symbol: GBP) has been the most volatile developed market currency. This was attributed, as you would expect, to the confusion surrounding the UK’s future economic partnership with the EU and other major trading partners following its expected imminent withdrawal from the bloc. Here we’ll take a fundamental look at Brexit pound trading.
Keeping abreast of fundamental news as day traders are normally on the backburner. Some technical traders don’t care at all about the press, because they just trade on technical analysis. In the long run, however, asset prices are changing based on economic pressures. This is also important on the daily stage. Technical research is one aspect of the toolkit, but we focus on important factors here.
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British Pound’s Current State
The pound has maintained a range between 1.20 and 1.44 after last reaching the US$ 1.50 on the day of the referendum.
The Brexit “deal or no deal” situation is about equal, maybe somewhat skewed towards “deal”. The pound is more on the upside than on the downside.
A tough “no deal” scenario seems fairly unlikely due to the effect that a disruption in goods imports and exports and travel delays would have on UK GDP. The possibility of UK GDP dropping by 0.5 percent per annum over the next decade. Plus would reduce the pound by around 10 percent to about 1.20 or just below. That will happen due to a re-rating of UK financial asset prices and a lowering of interest rates. Which would result in less desirable pound-denominated properties.
If you get a “no-deal” temporary the GBP will drop. This would be some form of deal where the UK offers to pay Brussels anything for a transitional time. This may also allow for an extension of the deadline of 29 March 2019 to facilitate further negotiations.
Any fall in the pound under these changes will certainly make it a quality long trade, as the currency will be forced to stabilize and recover. The biggest danger to the pound is a failure to reach any trade deal between the UK and the EU. Potentially leaving the UK isolated, which would have significant economic implications. But that is quite doubtful.
If you have a withdrawal bill and trade agreement in effect – that is, if the UK is still part of the Single Market (maybe not just for goods, but also for services and labor, too) – with the transition deal in place until December 2020, the associated “cliff” anxiety will stop.
Accordingly, you’ll probably get up to around 1.45 against the dollar and 1.33 against the euro on a rally.
If there is a second – but very doubtful – referendum, you will get 1.50 or more against the dollar and up to 1.40 against the euro. It could take the form of a general election with the opposition Labor Party campaigning “Remain” with incentives to hold a second vote on Brexit.
Many polls say that if another referendum was held, UK citizens would prefer to stay. This is only normal in view of the fact that shifts in the status quo typically add short-run costs that can be costly, unpleasant, and generate a bevy of negative headlines.
The General Strategy of Brexit Pound Trading
The pound at 1.30 to the US dollar is marginally cheap, on fundamental factors alone. Any “no deal” situation would result in the pound falling back into the 1.20s. However, a scenario of “deal” will put it at approximately 1.45 or greater. This means the reward/risk trade-off usually favors being long the pound compared to the dollar just off the pound-specific factors considerations themselves.
So far as the currency side of the trade is concerned – if you swap the pound against the dollar – the USD has had a good 2018. That momentum is fading, however. In the latter half of any developed market, the central bank’s the US is in the strongest rate-hiking period. It also reduced its holdings of bonds which remove liquidity from the financial system. This makes dollars scarcer, and raises interest costs in them, leaving all else equal.
But currency prices are not just about interest rates, however significant they are. The US is faced with persistent fiscal and current account deficits. This results in a disparity in revenue and fiscal imbalance. In the long term, and keeping all else equal, countries need to weaken their currencies to fill those holes. This allows them to pay off their debts more quickly and to increase exports or more imports to cover those deficits. Exports are more appealing to the rest of the world, as currencies weaken. Similarly, when the currency is relatively powerful, importing is more desirable, as a more expensive currency will potentially buy more goods and services.
In the US, tax cuts and deregulation’s optimistic economic results will shift in the other direction beginning in 2020, and begin to pull the US economy down. The positive outcomes of growth will begin to fade but the borrowing will continue, exacerbating US fiscal deficits. As far as macroeconomic accounting is concerned, the US government cannot keep issuing debt at an ever-increasing pace while maintaining business investment without expanding the trade deficit.
Consequently, the short-term cyclical boost for the dollar is being weighed against by the long-term reality of the US fiscal and current account deficits, which is a drag. Hence the dollar is likely to weaken, especially against gold, starting in the next 1-2 years out.
Bearish for the pound would be a “no-deal” Brexit situation. If temporary, it’s predicted the pound will fall, then snap back. It would be particularly bearish in the unlikely case that there is no contract at all and no planned contract in sight. Politicians will, however, fear the economic implications of this and be particularly driven to prevent anxiety.
A “deal” Brexit scenario would be positive for the pound and would likely result in the pound being driven back to 1.45+ against the dollar.
Essentially, the dollar is expected to weaken in the years ahead as the rate hiking cycle and balance sheet tapering by the Federal Reserve stops. The US must begin to face the financial reality of fiscal and current-account deficits, which are beginning to strain the finances of the country and becoming a drag on growth.