Every time Tory party leadership candidate Boris Johnson opens his mouth at the moment, the pound sells off some more. The sterling market is clearly worried about the impact of a no-deal Brexit on the UK economy. The leadership crisis and Theresa May’s failure to deliver a Brexit deal have already led to some aggressive selling of GBP in May in what has become an increasingly news-driven market.
Sterling briefly rallied from 1.26 versus the dollar at the end of last month and briefly broke 1.275 but since Johnson and other party leadership candidates have started to claim that a no-deal Brexit is a viable option and that they might even try to bypass Parliament to achieve this (precipitating a constitutional crisis in the process), GBP/USD has dropped again. It was at 1.256 at the time of writing.
Nigel Green, CEO of wealth manager deVere Group, said:
“The debate between the five men vying to be the UK’s next prime minister underscores that the pound can be expected to fall further. The chaos and uncertainty triggered by Brexit – which has recently intensified by the race to become the new prime minister – has put the pound on a considerable downward trajectory. An already battered pound has lost almost 5 per cent of its value against the U.S. dollar since the start of May. Similarly, it continues six straight weeks of falls against the euro.”
What the sell off in sterling also represents is the exit from GBP assets by international investors. The Armchair Trader has had the opportunity to speak with many investors and fund managers in the last three years about Brexit and their evaluation of its likely impact on the UK economy. Some remain bullish but many are starting to lose faith in the UK government’s ability to pull Britain out of its current political and economic swan dive.
“Sterling is increasingly reflecting the no-deal risk,” says Neil Wilson, Chief Market Analyst at Markets.com “Cable was last hovering close to its lowest of the year at 1.2530, having dipped as low as 1.2510, its weakest since the start of January. 2018 lows around 1.2470 could be the next target on the downside. [The Bank of England] this week may signal tightening bias and readiness to hike earlier than previously expected, but the pressure on the pound remains because of Brexit. The BoE should be minded to remain on the sidelines until Brexit is decided.”
Investors are becoming more focused on the pound as the leadership contest drags on. They are doing the maths on the time that is left between now and the end of October, the EU’s current Brexit deadline. It is looking highly unlikely that the government can deliver on a Brexit deal before then.
“The acid test for the UK though will come in October and early November,” says Thomas Wells, a fund manager with Smith & Williamson. “If there is no deal, some forecasts suggest that sterling could fall by 15%, and the outcome could be worse than that if GBP slips its anchor due to capital outflows. That would lead to a material uptick in inflation and inflation expectations – it is important to remember that the UK runs a large trade deficit with the rest of world and a currency depreciation of that magnitude would be extremely painful for consumers due to a sharp rise in the cost of imports.”
This paints a drastic scenario for the UK economy in Q4. For the forex trader it looks like the shorting opportunities against the GBP will remain consistent and profitable over the summer months. The sterling market will be following the political news flow and any further hard Brexit pronouncements will see further GBP sales. Certainly the short GBP market has looked like an excellent short trade in the second half of May and into June, and we don’t see that letting up anytime soon.