Three scenarios for Brexit and GBP/USD as talks reach critical stage

• A Brexit extension is the most likely scenario and would see GBP/USD retreating.
• A last-minute deal has medium probability and would send sterling soaring.
• The pound would tumble on the remote chance of a no-deal Brexit.  

The relative calm in GBP/USD fools no one – the clock is ticking down to  Brexit  Day, and when  news  headlines meet nervous hands, high  volatility  is expected. At the time of writing, the EU has rejected Prime Minister Boris Johnson’s proposal but is ready to negotiate.

Before diving into the three scenarios and GBP, here is a quick look at the timetable.

Brexit Timetable

1. October 11: OctroberFrench President Emmanuel Macron has given Johnson until Friday, October 11, to come up with new proposals. That deadline may come and go. Macron has played the “bad cop” in the EU, leaving the “good cop” role to German Chancellor Angela Merkel.
2. October 14: This is the day penciled in for the Queen’s Speech. The PM lays down his domestic agenda and asks parliament to approve it. The House of Commons has rejected Johnson’s legislation and may do so again.
3. October 17-18: EU leaders convene in Brussels for the EU Council, and Brexit tops the agenda. Both sides are aspiring to strike a deal at that event.
4. October 19: The deadline of the Benn Act that forces the government to ask for an extension to Brexit is parliament fails to agree to any other arrangement.
5. October 31: Brexit Day.

1) Brexit extended to January 31 – downdrift to 1.20

This scenario has the highest probability as positions on both sides of the Channel seem irreconcilable. It is impossible to keep Northern Ireland (NI) in a customs union with the EU, to align it with Britain, to allow the UK to strike independent deals and to refrain from erecting barriers in the Emerald Isle all at once.  Something has to give – and it is not happening just yet. Creative solutions have come and gone and there is little time to find one.

According to the Benn Act, the PM must ask for a delay of three months in Brexit until January 31, 2020, f parliament does not agree to leave without a deal by October 19. While Johnson has insisted that the UK will be leaving “do or die” / “come what may”, he admitted that he will obey the law. In a submission to a court in Edinburgh, the embattled leader accepted the law.

The opposition hopes that by humiliating Johnson he will lose votes to the extremist Brexit Party led by Nigel Farage and split the Leave vote in the upcoming elections. However,  most Conservative voters will understand that the extension was forced upon him. Moreover, commentators in the pro-Tories Telegraph have already begun preparing the public for such an option.

Johnson is likely to calculate the risking another brush with the law – as with unlawful parliament prorogation – is too much of a risk and that his supporters will stick with him. By going too far, the opposition may unite to oust him – something they have failed to do so far.

In this scenario, he receives the extension, calls elections – which the opposition vowed to support after a no-deal Brexit is avoided – and remain  the favorite to win.

In this case,  GBP/USD may initially rise on averting a no-deal Brexit, but fall immediately afterward. Why? A three-month delay extends the uncertainty for businesses. A potential win for Johnson means that a no-deal Brexit is still on the cards – it is just delayed. And a win for Labour is unappetizing either – markets fear Labour leader Jeremy Corbyn’s hard-left policies.

GBP/USD may, therefore, experience a knee-jerk relief and then a  gradual drag toward 1.20, edging toward the 2019 low of 1.1958. The scenario has a high probability.

2) A Brexit deal is reached and approved – shooting to 1.32

A deadline sharpens minds – when push comes to shove, leaders may thrash out an accord. The EU may accept some tweaks to Johnson’s proposal and another option would be reverting to former PM Theresa May’s original proposal – a  backstop only for Northern Ireland.

Such an accord would keep NI fully aligned with the Republic of Ireland, allowing free movement of goods and people, while creating a border between Great Britain and the territory. That would be unacceptable to the Northern Irish Democratic Unionist Party (DUP)  which opposes any step that may detach it from the UK.

However, Johnson’s Conservatives have already lost their majority and  do not depend on the DUP anymore. Moreover, surveys of Tory members have shown that  they care about Brexit more than anything else  and are ready to lose both NI and Scotland for the goal of leaving the EU.

Most importantly,  several dozens of Labour MPs from Leave-voting constituencies may support the deal, joining Tory rebels and securing a majority. Johnson’s conference slogan of “Get Brexit Done” resonates with many voters – also those that vote Labour.

In this case, markets will release a collective sigh of relief. Securing a smooth Brexit – albeit one creating long-term damage to the economy – is better than a disorderly exit.

In this scenario, which has a medium probability, GBP/USD may surge to 1.32  

3) No-deal – Crash to 1.10

In this scenario, the UK and the EU fail to reach an accord at the EU Summit and Johnson will refuse to ask for an extension. The opposition, already on alert for such a move, will run to the courts. Nevertheless, 10 Downing Street will somehow manage to drag the time and leave on  October 31.

However, it is hard to see 12 days passing by without the courts stopping it. Moreover, the opposition may finally unite behind one leader, table a Vote of No Confidence and oust Johnson. A caretaker PM, either Labour’s Corbyn or a veteran from one of the big parties, may take over and ask for an extension.

Another option is that  one of the 27 other EU countries will veto an extension. A veto may come upon a secret request from London or via a genuine rejection by one or two countries. That would be enough to trigger a hard Brexit.

The chances are very slim, but in such a case, GBP/USD could crash spectacularly, with 1.10  serving as the initial target in which buyers come in.

The next moves depend on the following days. If long lines of trucks and food shortages dominate the headline,  sterling  could continue suffering. If economic damage on both sides finally triggers a deal,  the pound  may rebound.

Conclusion

There are three clear scenarios for Brexit at this juncture. Another extension is the most likely event and would eventually see  GBP/USD  retreat toward 1.20. Reaching a deal has a medium probability and would lead to a surge to 1.32. A no-deal Brexit, which has low chances, may send the pound plummeting to 1.10.