The Pound Melts As Brexit Goes To The Wire
Summary
- Europe agrees with the Prime Minister’s plan.
- Issues on the home front: contempt of Parliament?
- The pound decays as time is its enemy; the EU helps stoke domestic issues for Prime Minister May.
- A deal by the March deadline.
- A recovery in the pound; buy the FXB scale-down on weakness but stop out if there is a no vote on December 11.
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The events surrounding the final form of Brexit have been picking up steam over recent weeks, and on Tuesday, December 4 they reached a new peak.
In June 2016 when the United Kingdom voted to divorce from the European Union, the world was shocked by the vote. The narrow margin of victory led to a new Prime Minister for the UK as David Cameron stepped aside and Theresa May took his place. The value of the British pound against the dollar plunged in the aftermath of the Brexit referendum moving from a high at $1.5009 in June 2016 to a low of $1.2001 in early 2017. In hindsight, the U.K. never wholly bought into the EU as they held onto their currency, the pound, and refused to retire their monetary instrument in favor of the euro.
Over the past two and one-half years, Prime Minister May has worked on a deal that would result in the divorce the voters had approved. The task for the leader of the U.K. was formidable. Any deal had to meet with the approval of the European Union, the voters of the U.K., members of Parliament, and her Tory party. Pleasing just one of those constituencies would be a steep mountain to climb, coming up with a deal that all could live with has been nearly impossible.
The pound rose to a high at $1.4413 against the dollar in mid-April as the Prime Minister put the pieces together for a deal. However, the British currency has been falling like a stone since then and on Tuesday, December 4 it hit a new low for this year at $1.2665. The Invesco Currency Shares British Pound ETF product (NYSEARCA:FXB) does an excellent job replicating the price action in the U.S. dollar versus the British pound currency relationship. On Tuesday, the uncertainty over the final form of Brexit sent the FXB to its lowest level since June 2017.
Europe agrees with the Prime Minister's plan
After more than two years of back and forth negotiations between Prime Minister May and her counterparts in the European Union the two sides have come to terms on a deal that would satisfy the majority of U.K. voters that voted to separate from the Union. The agreement is possibly the most complicated divorce in history as both sides needed to protect their rights and futures. When it comes to Europe, the deal could not make it too easy for the British to exit as it will set a precedent for any futures departures.
The voters in the U.K. and leaders in Parliament who supported the departure from the Union were against any deal that gave Europe too much of an upper hand in future trade and other issues that will impact the country that will continue to remain Europe's neighbor. There is nothing that Prime Minister May or any leader can do about the geography issue. Pro-Brexit leaders and voters objected to Europe's policies inflicted on the home to the former center of the Commonwealth. The U.K. found itself in a position where decisions were being made in Brussels and Frankfurt and London, and the rest of the nation had to march in line. From a historical perspective, it was a reversal of fortune for the U.K. who has a long history of making decisions in London that impacted members of their Commonwealth in faraway lands. The latest form of a Brexit agreement has been acceptable to the EU leaders who approved the plan at the end of November, but that amounts to only one part of a broader group that needs to get behind the deal that will finally settle the divorce.
Issues on the home front - contempt of Parliament?
Perhaps Prime Minister May's greatest challenge has been herding the political cats within her nation. On Tuesday, those cats scratched her badly as they voted to find her government in contempt of Parliament for the first time in history. The vote of 311 to 293 found that the refusal to publish the full legal advice that led to the final form of the Brexit plan was contempt. The Prime Minister had argued that candid legal advice given to minister must remain confidential, but the majority of the Parliament disagreed. The contempt vote was only one of several defeats for the Prime Minister on Tuesday as they also voted to give Parliament more power if they reject May's plan. The final vote is set for next week on December 11.
The contempt of Parliament vote is a first, and it could be a harbinger of a no-confidence vote which would replace the sitting Prime Minister. The currency market did not like the events that took place in Parliament on Tuesday one bit, and the pound slipped briefly to a new low for 2018.
The pound decays as time is its enemy; the EU helps stoke domestic issues for Prime Minister May
After hitting a high at $1.4413 against the dollar in April, the pound has been falling steadily as the drama of Brexit has weighed on the currency.
Source: CQG
On Tuesday, the pound hit a new low for the year. It appears that the EU is rubbing some salt in Ms. May's domestic political wounds. On Tuesday, in the face of a contempt of Parliament vote and a successful motion that will allow members of Parliament to take control of the exit plans if it fails on December 11, the EU stated that Britain could "change its mind" and remain within the EU. The legal opinion from the EU that Parliament can defy the voters and ignore the result of the referendum only complicates the current situation and puts the Prime Minister in a corner. The President of the European Council, Donald Tusk, said that if the U.K. does not take the standing deal, there will be no other deal as he delivered an ultimatum. The E.U. has only made the Prime Minister's position more untenable within the United Kingdom. The December 11 vote in Parliament is now a line in the sand. If Brexit passes, the divorce will proceed. If not, the U.K. will likely need a new Prime Minister, and the result could be a period of anarchy leading to the early 2019 deadline.
A deal by the March deadline
Time is running short for the U.K. and the E.U. when it comes to Brexit. The March 29, 2019 deadline marks the date that the U.K.'s membership in the E.U. officially expires where or not there is a deal. In the event December 11 comes and goes without a favorable vote in the Parliament the pound is likely to tank and move to the early 2017 low at $1.2001 against the dollar or lower. If March 29, 2019 passes without a deal three million E.U. citizens living in the U.K. and one million British nationals living in E.U. member nations will lose all automatic rights and protections overnight. At the same time, air travel in the U.K. would immediately cease, and supermarkets could run out of food. The bottom line is that time is running out. The December 11 vote is not a line in the sand, and while it could unseat the Prime Minister, the March 29 deadline has the potential of causing a political catastrophe in the United Kingdom.
A recovery in the pound: Buy the FXB scale-down on weakness but stop out if there is a no vote on December 11
The high odds are that Parliament will begrudgingly approve the Brexit plan which would be the final hurdle for the divorce. However, another surprise that puts the future of Brexit in the hands of the herd of cats in Parliament would be political suicide for Brexit proponents who may find themselves in a situation where they must remain within the Union to avoid political and economic disaster. I am a buyer of the pound, and the Invesco Currency Shares British Pound ETF product (FXB) on the current price weakness as the December 11 vote approaches. I will stop out in a heartbeat if the Prime Minister suffers another defeat on that day which will be her final stand and a nightmare for the people of the Kingdom. However, passage will likely cause the pound to recover from its current level, and when it comes to politics and economics, the members of Parliament are facing a vote where there is no choice other than to bite their lips and vote for the plan. The fund summary for FXB states:
The investment seeks to reflect the price in USD of the British Pound Sterling. The shares are intended to provide institutional and retail investors with a simple, cost-effective means of gaining investment benefits similar to those of holding British Pounds Sterling.
The pound is now at the bottom of its trading range in 2018 and approaching the early 2017 lows. 
Source: Barchart
As the long-term chart illustrates, the pound is not far off its lowest level in over a decade against the dollar at $1.2730 as of the close of business on Tuesday, December 4. Risk-reward favors a recovery, but that depends on the December 11 vote. Next week at this time, the ink will be drying on the Brexit divorce, or the U.K. will be heading for a period where the nation will face its most significant challenge since World War II.
Many contentious divorce cases come down to the wire when both parties realize that they should get on with their lives and settle. My bet is that the U.K. will do the same next week. If I am wrong, there will be hell to pay in the U.K. and the impact could cause contagion in markets that will ripple across the globe like a tsunami.
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This article was written by
Andy spent nearly 35 years on Wall Street, including two decades on the trading desk of Phillip Brothers, which became Salomon Brothers and ultimately part of Citigroup.
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