Here's What FX Traders Should Watch as May Faces Brexit Votes
(Bloomberg) -- The pound is vulnerable to swings Tuesday as traders tweak positions ahead of votes by lawmakers to change Theresa May’s Brexit plan.
A one-day gauge of volatility in the currency climbed to near the level seen before lawmakers rejected May’s deal earlier this month, with options trading at double the normal volumes. Sterling could rise to the highest in six months if Parliament votes for the so-called Cooper-Boles amendment, which seeks to defer the U.K.’s departure from the European Union if there’s no deal.
Yet it could lose some of this year’s gains if a rival proposal is passed to change the plan to avoid a hard Irish border and send May back to the negotiating table with the EU. The prime minister urged lawmakers on Tuesday to back this option, increasing its chances.
Any news seen as negative could spur an outsized move downwards for the pound as traders rush to exit long positions, according to Russell Silberston, a portfolio manager at Investec Asset Management. Hedge funds and asset managers have recently been buying sterling, according to traders, making it this year’s best-performing Group-of-10 currency.
Parliament will vote on the proposed changes to May’s beleaguered Brexit plan from 7 p.m. London time. These aim to send May back for talks on the backstop, give lawmakers more control, delay taking the U.K. out of the bloc or avoid no deal. These are the key amendments the market is focusing on:
The amendment: This cross-party effort, by Labour lawmaker Yvette Cooper and Conservative politician Nick Boles, would set a time limit beyond which the prime minister would have to ask for an Article 50 extension until the end of the year if no agreement has been struck.
Pound reaction: “Cooper/Boles we think is small upside for the pound, as delay is always preferable to a forced decision,” said Royal Bank of Canada’s chief currency strategist Adam Cole.
Lee Hardman, an analyst at MUFG, sees the pound rallying as much as 1.6 percent to $1.3370 under this scenario, a level the currency hasn’t reached since June 2018. Banco Santander SA’s head of Group-of-10 currency strategy Stuart Bennett agrees, putting the currency between $1.33 and $1.34.
The amendment: A proposal aimed at getting May back to Brussels to renegotiate the Irish backstop has been submitted by Conservative backbencher Graham Brady. It calls for the Irish border proposal to be replaced with “alternative arrangements.” If passed it could serve as a first step toward a compromise -- known as the Malthouse plan -- which May said she would engage with. Still, this would wreck her agreement with the EU, which has said there is little chance of removing the Irish backstop.
Pound reaction: Anything that means the EU has to re-open negotiations would be taken negatively, according to Investec’s Silberston. It would result in “even more uncertainty and possibly a step backwards,” he said.
If the Cooper amendment fails and this one passes, the pound could drop as much as 2 percent on a trade-weighted basis, according to Silberston. It could hit $1.31, according to MUFG’s Hardman.
“The Brady amendment will still fail, but by a much smaller margin than the original bill, which will give her something to go back to Europe with,” said RBC’s Cole. “To the extent that does not really resolve anything and just leaves the uncertainty overhanging, it is probably a small negative for sterling.”
Spelman No Deal
The amendment: Former Conservative minister Caroline Spelman and Labour’s Jack Dromey have joined forces to try to stop a no-deal Brexit.
Pound reaction: “In case of the Spelman amendment, the pound should react positively, as no deal would be ruled out, although it remains unclear how this would be done in practice,” said Thu Lan Nguyen, a currency strategist at Commerzbank AG.
Rabobank’s head of currency strategy, Jane Foley, expects the Spelman amendment would be “most positive since it would remove the threat of no deal.” Still, $1.32 would likely remain a tough hurdle for the currency to clear as the amendment being approved doesn’t remove the uncertainty around how to move forward.
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