There Won't Be A Brexit: Buy The Pound

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Includes: FXB, GBB
by: Jeremy Blum
Summary

Since the vote, numerous things have happened making odds on a Brexit much less likely.

Plenty of time and many obstacles for cooler heads to prevail.

You can play it by going long the pound versus the dollar.

Background

Brexit is short for British exit from the European Union. On June 23, 2016, the British narrowly voted to leave the E.U. by 51.9% to 48.1%. The vote was a surprise; polls had indicated it would go down in defeat. On March 29, 2017, Prime Minster Theresa May triggered Article 50 of the EU officially notifying the EU the U.K. would leave. This gives the U.K. two years to negotiate an exit and new trade agreements. If no deal is reached, the relationship between the E.U. and the U.K. will be governed by the World Trade Organization (WTO) and the U.K. will be subject to whatever tariffs the E.U. wants and customs checks.

Recent Events

The race for Prime Minister was supposed to be a cakewalk for the Conservatives and Theresa May, the incumbent. However, their lead over the Labor Party led by Jeremy Corbyn has been cut in half in recent days. Some of this appears to be a weak campaign on her part. However, it is the Labor Party that supports remaining in the European Union more than the Conservatives. In fact, the Conservatives have been moving away from Brexit themselves.

Reality is setting in. Theresa May hoped for a quick trade deal to replace the EU. However, European leaders have showed unusual unity in demanding major consequences to Brexit. The impact of a Brexit will be felt in the following areas:

  • More red tape in trade.
  • Possible tariffs.
  • Loss of much of the high pay financial industry.
  • More restrictive travel between Northern Ireland and Ireland.
  • Impact on U.K. expats living the E.U. and vice versa.
  • The U.K. will likely need to pay tens of billions of Euros to leave to cover budget commitments.
  • Some multi-national corporations may move operations or even headquarters out of the U.K.

Prime Minister Theresa May will likely be re-elected on June 8th. She was opposed to Brexit but since becoming Prime Minister has favored it because that is what the people want. She is a poll watcher just like most other politicians. It stands to reason she will stop the Brexit process if it becomes clear a majority of the people oppose it. Polls are moving in that direction.

Path Forward

The U.K. government has said any Brexit deal reached will need to be approved by Parliament. This is a major obstacle.

The pound has fallen significantly since the vote. The pound was worth $1.46 just prior to the Brexit vote and is worth $1.29 now. Investors are concerned with a significant negative impact on the economy. One very likely impact is many of the high-paying financial jobs now in London will be forced to move onto the continent.

Negotiation will be long and cumbersome. The recent EU and Canada trade agreement is 2,255 pages long. EU officials have repeatedly told the British the process will be longer and harder than they think.

While England and Wales voted for Brexit, 62% of Scotland and 56% of Northern Ireland voted to stay. The Scots in particular recently had a very close vote of their own on whether to even remain in the U.K. This could be enough to cause them to re-vote and leave the U.K. this time. Scottish National Party leader Nicola Sturgeon has already called for a second independence vote prior to the finalization of Brexit.

It is not in the E.U.'s best interest to allow a "soft" Brexit as that becomes an existential threat to the E.U. making it easier for other members to leave.

Why the U.K. Won't Leave

1. Major corporations and industries will lobby hard against it as less free trade will hurt them.

2. Polls are moving away from Brexit. The latest showed 45% against and 43% for.

3. Polls will continue to move away as the ramifications become more clear.

4. Economists and investors will be opposed as they know any movement away from free trade is usually bad.

5. Theresa May was opposed to Brexit and will likely stop the process if polls continue to move against Brexit.

6. Theresa May will have more flexibility to stop Brexit after the Conservatives win the upcoming election.

7. Movement by the Scots for another independence vote will turn many against Brexit.

8. Brexit was a populist reaction. Populism sounds good but doesn't usually go very well. Many will link voting for Brexit with the U.S. voting for Trump, a populist and anti-immigrant, who is not popular in the U.K.

9. One of the main reasons for Brexit was immigration issues. This can be much more easily negotiated with the E.U. than a Brexit.

10. There is a big difference between saying you want to do something that is risky and potentially painful and actually doing it.

11. Any slowdown in the U.K. economy will move more voters against Brexit.

12. Brexit was supported most by older voters and least by younger voters. Demographics favor the younger voters. If a deal is reached that is harmful, it will likely fail in parliament.

13. The lower pound has already impacted the country by raising prices, especially for fuel.

My sense is, many of the U.K.'s political leaders are just looking for an excuse not to go forward. When that excuse arrives cannot be estimated.

How to Play it

The biggest impact so far has been the decline of the pound from about $1.46 just prior to the Brexit to $1.29 now. The pound had been as high as $1.72 two years ago. The decline was immediate after the vote and would likely snap back if Brexit is scrapped. It will likely steadily climb as the odds against Brexit increase.

I prefer going long the pound versus the dollar instead of against the Euro. The U.S. economy is further along the economic cycle than the EU indicating it is likely to weaken against the Euro as Europe strengthens from a long period of weakness. Unlike many other trades, this trade probably has a measurable term. If Brexit is scrapped, it is likely to happen in the next two years.

Disclosure: I am/we are long THE POUND VERSUS THE DOLLAR. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.