Ok, so sterling had its best day since 2008 on Tuesday.
It was as if everyone suddenly forgot the rationale behind the short bias that on Sunday pushed cable below 1.20 for the first time since the October flash crash (for those who are interested in black swans and multi-sigma events here’s the full flash crash breakdown).
Although one could point to the overall upbeat tone of May’s speech (not to mention a rather dramatic short squeeze) as the impetus for the sharp move higher, the specific catalyst for Tuesday’s rally seems to have been the PM’s promise to put the final Brexit deal to a vote in Parliament.
As I wrote on Tuesday evening, the sharp reversal in the pound was yet another example of the phenomenon that’s helped to fuel a groundswell of populist sentiment both in the US and across the proverbial pond. Status quo economists are perhaps too quick to suggest that this or that discrete event (be it a speech or an election or something else) will lead invariably to economic catastrophe. When those predictions don’t play out, the electorate sees it as yet another example of the establishment telling lies to protect its own interests.
But the thing is, it will likely take years for the dangers associated with a shift towards populism and nationalism to manifest themselves in economic outcomes and it will take months for the consequences to produce a sustainable downturn in asset prices.
But one shouldn’t be fooled into believing that these political shifts won’t eventually come home to roost vis-a-vis markets. On that note, consider the latest from Goldman on the prospects for sterling which, by the way, retraced by around 1% at session lows on Wednesday.
Prime Minister May’s speech painted a rosy future for the UK outside the European Union and at the centre of the global economy, but the near-term implications of the speech look to us quite different and more negative than the interpretation embraced by markets. The speech left no doubt that the UK is prepared to move towards “hard Brexit”: whether the European Union will be willing to negotiate freetariffs agreements while the UK restrains immigration from EU countries and removes itself from the European Court of Justice’s jurisdiction remains highly unlikely, in our view. The UK’s position on its contribution to the EU budget and the threat of significant tax reductions also have the potential to toughen the EU’s negotiating stance.
The European Market, due to its size, is more important for UK trade than the UK is for the European Union and, in our view, PM May’s ‘red lines’ remain incompatible with deals that de facto would grant the UK free access to the Single Market.
All of this is unlikely to be positive for the UK and its currency in 2017; yet, Sterling recorded the largest positive daily move since 2008. Although positioning, a stronger-than-expected UK inflation print and President-elect Trump’s comments on the value of the USD could also have contributed to the Pound’s appreciation, GBP/USD strengthened during the Prime Minister’s speech, which suggests to us that the market had a more positive take on the government’s plan than we do.
For all these reasons, we see the squeeze higher in Sterling as a better entry point to take short positions on GBP/USD