The British government is about to make Brexit official by triggering Article 50 of the Lisbon Treaty on March 29th. The historic day follows the EU Referendum held more than nine months beforehand.
On the Brexit vote, the pound crashed, and then continued to lower ground around the flash crash. PM Theresa May’s tilt to a “Hard Brexit” weighed heavily on sterling. She drew out her intent and signaled the end of March as a trigger date.
Legal and political hurdles did not stop the move and on March 29th, the UK says goodbye. This starts a 2-year period of negotiations and the EU is set to get tough. A 5-year transitional deal would be more favorable but this is far from being guaranteed.
Here are three scenarios for the momentous event:
GBP/USD – 3 scenarios
1 – Nothing at all
What will happen on the day itself? It may result in nothing at all: end-March was talked about since October and the exact date of March 29th was also reported in advance.
So in theory, the pound should move only when details about the negotiations emerge. Advances in talks should benefit the pound while frustrated talks could hurt it. And either progress or a blow up in talks could take a while. There were reports that talks would commence only in June.
In this scenario, the most recent levels remain relevant: 1.2630 on the topside and 1.2540 on the downside, as cable is confined and awaits bigger news.
2 – Short squeeze
Speculation against the pound is rife: according to CFTC data, there is a record level of pound shorts. When everybody is short, who is left to sell?
Previous episodes with the euro have often resulted in a squeeze: a sudden rush to exit these shorts resulting in a massive rise. This was also seen in the recent Fed decision. Yellen and her colleagues telegraphed a hike in a well-coordinated fashion. On hike day, the dollar actually fell. That was due to other factors as well: the Fed was dovish.
What factors could support a short squeeze of sterling? A conciliatory message from PM May or a quick positive response from EU officials such as Donald Tusk or others could alleviate fears. Even if negotiations do not start immediately, a constructive tone from both sides could start the short-squeeze fire.
In this case, GBP/USD could shoot up to an initial high of 1.2790. This was the first post-Brexit low. From there, resistance awaits at 1.2850 and then the round number of 1.30.
3 – Just short
Despite the massive short positioning, Brexit is still bad news. Similar to the scenario for a short squeeze, the tone could be negative. If the Fed had delivered a “hawkish hike” with upgraded forecasts, the dollar would have surged and we would not have seen a “buy the rumor, sell the fact”.
In this case, a tough stance from May on immigration and more importantly a willingness to suffer the consequences of staying out of the single market could hurt the pound. A negative response from Tusk could
A negative response from Tusk could exacerbate the situation. EU officials could stress that being out means receiving less than being in and hinting that the UK must be punished for the decision to leave. Deterring other countries from following suit is a not-so-hidden goal of the club.
In this case, GBP/USD could fall sharply: 1.2415 would be the initial level of support, followed by 1.2360, 1.2250, 1.21 and 1.20.
Which scenario will prevail?
With little information about the nature of the Brexit statement or the Brexit response, scenario No. 1 has the highest probability: more wait and see until the negotiations with little volatility.
However, pound/dollar enjoys quite a bit of volatility lately and markets have become more sensitive to politics. Yet again, it is hard to gauge if we will hear a positive or a negative tone.
What do you think?
More: GBP/USD: Reluctant rally as Brexit is about to become official [Video]
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