Pound Traders Indulge in Some Wishful Brexit Thinking

(Bloomberg Opinion) -- The U.K. Parliament has inflicted the biggest-ever defeat on a sitting government in the country’s modern history. It has pretty much shredded the only deal agreed by Brussels and London for a Brexit on amicable terms. The deadline of Article 50 (the two-year withdrawal process) draws near, and there’s still no solution beyond the dread prospect of the U.K. automatically crashing out of the EU on March 29.

Yet the desire to put a positive spin on things is everywhere, and not just at 10 Downing Street, where Theresa May was nursing the wounds from that historic 230-vote defeat on Tuesday night. The pound rebounded in the immediate aftermath of the ballot to about $1.29, which Bank of England Governor Mark Carney attributed to the diminishing — yes, diminishing — risk of Britain crashing out without a deal.

The potential for over-optimism is high, both in the markets and in London’s corridors of power. Over in Brussels and the European capitals, the sentiment was very different. May’s crushing loss sparked talk of the rising risk of a “no-deal” Brexit and a dogged refusal to renegotiate the agreement rejected by British lawmakers. One German asset manager, Stefan Kreuzkamp at Deutsche Bank’s DWS, said: “We have to acknowledge that the probability of a hard Brexit has increased. Even though the majority of British MPs claim that they want to avoid it.”

For currency traders, though, this was mere noise from across the English Channel. Their focus was on reading the runes of Parliament, with plenty of political commentators interpreting May’s promise of seeking a “cross-party” consensus as cutting the risk of a no-deal. Indeed, the implied probability of that ugly outcome, based on British bookmakers’ odds, has slumped.

Yet even if the U.K. does see sense and takes the prospect of a disorderly exit off the table, it still needs to find some kind of majority in Parliament for one of the other options: an even softer version of May’s Brexit, with Britain remaining part of the EU customs union and possibly its single market; or a second referendum. As my colleague Therese Raphael points out, there is no consensus position in Parliament other than abhorrence of “no-deal.” Another general election remains possible given the logjam.

With no consensus for anything, pound optimists believe anything is possible — in a Panglossian sense. This explains the trade made by hedge fund investor Crispin Odey, who is leaning toward a sterling-positive outcome (although FX traders won’t make any calls beyond a few days).

But if it’s true that anything really is possible, this should include negative stuff too. No-deal is still the default option. And while a second referendum is seen as a good thing by the markets — as it raises the chance of canceling Brexit altogether — it might make the deep divisions in the country even worse. If the opposition Labour Party manages to force a general election, the pound bulls can look forward to its hard-left leader Jeremy Corbyn maybe occupying Number 10. 

Those making confident pronouncements on the next phase of Brexit may not be acting on blind faith, and on balance the chances of “no deal” are outweighed by the plethora of other possibilities. But just as nobody in Parliament knows what’s going to happen, neither do traders. As Dean Turner, U.K. economist at UBS Global Wealth Management, put it (in beautifully deadpan fashion): “At this stage we do not advocate taking directional views on sterling and U.K. assets.” Elsewhere in the markets, there may be a bit of selective hearing going on.

To contact the editor responsible for this story: James Boxell at jboxell@bloomberg.net

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Lionel Laurent is a Bloomberg Opinion columnist covering Brussels. He previously worked at Reuters and Forbes.

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