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- For Sterling "hope is a powerful thing"
- Return of MPs next week could offer further upside impetus
- Market continues to unwind short positions against Sterling
The British Pound continues its short-term recovery as markets sense the prospect of a 'no deal' is once again diminishing, and one currency analyst tells us the gains can extend.
The Pound-to-Euro exchange rate has recovered from two-year lows down at 1.0724 to trade at fresh three-week highs at 1.1070 at the time of writing, and politics is once again responsible.
"Parliament’s return next week could see positive tail risks creep into pricing," says Jordan Rochester, a strategist with Nomura, the Japan-based global financial services provider.
According to the analyst, the Pound has rallied over the course of the past week based on two distinct drivers:
1) The EU have dropped their red line that the Brexit Withdrawal Agreement is closed and the Northern Irish border backstop is not open for discussion. This gives hope that a deal can still be done. “There has been a rhetorical shift from the EU compared to a month ago, when they were insisting that the backstop and the withdrawal agreement were sacrosanct,” a UK government source this week told the Financial Times.
2) Opposition parties have met to agree a strategy to block 'no deal' in Parliament.
"This is a big hurdle and very unlikely in such a short time, but hope is a powerful thing and we think the market has already started reducing its GBP shorts," says Rochester, in Nomura's London office.
The market has built up 'short' position on Sterling - i.e. entered into trades that deliver profit when the Pound falls - since May when it became clear the existing EU-UK Brexit deal would not pass through parliament.
This failure to pass a Brexit deal in turn triggered a change in Prime Minister and official Brexit policy, which ultimately meant expectations for a 'no deal' Brexit rising to above 40% according to various market gauges.
Now that the Brexit pendulum is swinging away from a 'no deal' again, the Pound has been able to recover as 'short' bets against the currency are cleared from the market.
In short, traders are judging that betting against Sterling no longer offers the rewards that it once did as any chance of a 'no deal' being avoided poses substantial recovery potential for Sterling.
"The good news for trading GBP in the short term is that the likelihood of a no deal Brexit is already elevated at this stage, around 40% or so (Betfair) and the FX market is overly short GBP. This implies that one needs really bad news such as proroguing parliament (6 September court case could be important) to keep GBP on the downward trajectory it had earlier this summer," says Rochester.
Nomura is of the view any sign of legislation by opposition MPs to stop a 'no deal' Brexit would likely see a considerable reduction in positioning against Sterling, which would ultimately go higher as a result.
Based on this view, Nomura is entering a tactical trade that delivers profit on any further recovery in Sterling.
They are targeting a rise in GBP/EUR to 1.13.
"It’s a tactical trade and is likely to be held hostage to the politics next week when Parliament returns. However, the probability looks to be in favour of GBP longs, given the market has naturally been focused on the downside tail risks and little of the potential positives of parliaments return," says Rochester.
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