Back in August, I made the argument that the United Kingdom would experience significant uncertainty before and if a Brexit deal is reached with the European Union. As such, I expressed my view that the British pound is currency best avoided for the time being as it would likely experience significant volatility and uncertainty in the interim.
However, since August, we have seen a significant rise in the GBP/USD when looking at the 1-day chart:
Taking a wider look at the monthly chart, we see that the currency has not seen much upside past the 1.40 level since 2016 when Britain voted to leave the European Union.
Holistically, the GBP/USD appears to have zig-zagged between the 1.20 and 1.40 level over the past two years – due to both uncertainty on the severity of Brexit as well as significant buying on weakness. However, the pound has consistently failed to return to pre-Brexit levels against the greenback, and I anticipate that this will continue to be the case.
In particular, the International Monetary Fund has already given significant warnings about the consequences of a “no-deal” Brexit, which would mean a substantial increase in Britain’s budget deficit as the country would need to increase government spending to minimise significant damage to growth, and the British pound would be very likely to weaken further as a result. While the deficit has returned to levels seen before the financial crisis, a no-deal Brexit would be likely to change this as trade barriers would place excessive tariff costs on both imports and exports.
That said, the British pound has benefited from renewed speculation that a deal could be reached sooner than expected, and markets are therefore being too pessimistic in relation to the GBP. According to PIMCO, there could be up to 10% upside in the British pound if a deal is reached. Assuming that this is the case, then the GBP/USD could rise a further 10% from the current level of 1.3192 to 1.45.
While this may well be the case, let us assume for a moment that a no-deal scenario would bring the GBP/USD below a level of 1.20, which is the lowest we have seen the currency trade since the Brexit vote was announced. In this instance, the GBP could still have a downside of a potential 10% if a no-deal scenario materialises. From a technical perspective, this would mean that the potential risk-reward on the GBPUSD would be 1:1. In other words, the potential upside would still be the case as the potential downside.
In spite of the fact that the GBP/USD has been rising, I still do not see enough justification for being long the currency. While the currency may see some gains as the market looks for profit-taking opportunities, I still see the potential risk as too high, given the uncertainty on the outcome of Brexit.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.