Parliament didn't agree to Boris Johnson’s deal with the EU on Saturday, instead voting through an amendment requiring all legislation to enact the agreement to be passed before it can be voted on. As required by law, the UK government has asked for an extension of the Brexit deadline to 31 January 2020. We expect the EU will accept this extension rather than face a no-deal, although their decision may not be immediate.
In the short term the focus will now be on passing Johnson's deal, as there now appears to be a slim majority in favor of it. However, this will not be risk free as amendments to the legislation may derail the process. On balance, we think that the legislation will not be passed in time for an end of October departure, thus forcing an extension.
Sterling dipped briefly against the dollar on Monday morning in reaction to Parliament’s rejection of the deal, but at the time of writing had reversed its losses. Now trading at 1.2975, the pound is more than 6% higher against the dollar than its recent low on 9 October. Following the large moves in sterling over the last two weeks, we will likely see further volatility in the days ahead as the next phase of Brexit unfolds. We see three scenarios for sterling:
- Although the chances of a deal being agreed by the current parliament have risen, we still think that a general election will be needed for the PM to secure a stable majority to ratify it, and we expect one to be held before the end of the year. As investors assess the prospect of a general election, we expect GBPUSD to settle in a 1.26 to 1.32 range.
- Contrary to previous market concerns, it now seems more likely that Boris Johnson will be campaigning on a platform of having secured an agreement. The opposition Labour Party would be likely to campaign on the basis of putting the new agreement to a second referendum. The no-deal scenario, which would have pulled GBPUSD down toward 1.12 in our view, now appears the least likely scenario.
- If the deal eventually passes, we would expect GBPUSD to rally to 1.35. Beyond those levels, we think, sterling would struggle to rise, as concerns about the long-term trade relationship will come into focus. Moreover, the UK economy does not look to be performing particularly better than its peers at present.
For the time being we retain our overweight position in sterling versus the US dollar in our FX strategy. The size of the market reaction in the last week indicates that positioning was, and probably still is, relatively short in sterling, which corroborates the latest International Money Market data. Hence, strong upward moves could easily still be triggered, which favors retaining an overweight position in sterling.
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