The current probability of a no-deal

Today's news headlines:

  • ‘Conte to recall Italian parliament as Salvini seeks confidence vote'. Italian Prime Minister Giuseppe Conte will place the ruling coalition on the verge of collapse by recalling Parliament for a vote of no-confidence. Speculation over the future of the government had been mounting due to differences on fundamental issues between the League and Five Star parties. Tensions culminated after the anti-establishment Five Star Movement voted against a proposed transalpine rail link with France. (Financial Times)
  • ‘Boris Johnson eyes election in "days after' Brexit"'. The UK will head into a general election in the days after leaving the EU if a successful no-confidence is called against Boris Johnson's government. Johnson does not want to hold an election before Brexit but is expected to face a confidence vote as soon as Parliament returns from its summer recess. In response, leader of the opposition, Jeremy Corbyn, will seek a ruling that the government has to delay Brexit until after the election. Corbyn accused Johnson of an 'unprecedented, unconstitutional and anti-democratic abuse of power'. (Financial Times)

The worst-case

Only since Boris Johnson's ascent to Prime Minister did the risk of no-deal Brexit rise, and with it, the potential for a massive Pound devaluation. The Pound has taken a hit to its valuation of the past several weeks, moving towards all-time lows of its trading range—it would be natural to think that this might be the end of the pain.

Back in May of 2016 before the EU Referendum when HMRC published its Immediate Economic Impacts of Leaving the EU, under a 'shock scenario' the Sterling exchange rate was expected to decline by 12%. The expected impact to Gross Domestic Product was computed to decline by 3.6%. In fairness, the likelihood of a no-deal Brexit was only about 5.0% prior to Mr Johnson's arrival at Number 10, so this was viewed as scaremongering by Brexit proponents and mostly ignored as unlikely by everyone else.

The current probability of the UK withdrawal without a deal is now ranked closer to 50%, so it's no surprise to see the UK economic picture has slipped rather sharply as well. Released just this morning:
 

  • Quarterly GDP came in at -0.2% (worst reading since 2012)
  • Year-on-year Business Investment was -1.7% (hugging six-year lows)
  • Year-on-year Industrial Production was -0.6%
  • Year-on-year Manufacturing Production was -1.4%
  • Year-on-year Construction Output was -0.2%


Bottom line: The decline in global growth and slowing of UK domestic readings over the past months, makes the impact of a no-deal more dangerous than the 2016 report may have predicted. If you look at the real effective exchange rate—the nominal exchange rate adjusted for inflation and viewed as an index of trade weightings—the pound hasn't really shifted from its trading range despite the latest depreciation against the Dollar. This suggests the Pound isn't particularly undervalued even at current lows. A no-deal Brexit could easily result in the -12% decline predicted back in the 2016 HMRC report; that equates to about 1.0650 against the Dollar. 

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GBP/USD

The Sterling Index continues to trade relatively flat while the Dollar Index has calmed since the market turmoil at the beginning of the week. This has translated in steady trading for the pair which has been bound to the 1.21-1.22 region since the beginning of the month. In yesterday's session, reports that UK Prime Minister Johnson might call an election the day after Brexit sent the pair to weekly lows of 1.2095, although the shock quickly died out.

GBP/EUR

The pair has traded heavy this week due to a flat Pound and a rallying Euro. The pair has tested the 1.0812 support level three times this week and briefly broke through in yesterday's session. UK data out today could be the catalyst for sustained trading below this support level.

EUR/USD

Since Tuesday, the Euro Index has been supported by its 200-daily moving average having broken above the key level during Monday's market turmoil. The index continues to trade above this level this morning while the pair remains around the 1.12 figure.