A Busy Week For The U.K. - Keep An Eye On EWU

About: iShares MSCI United Kingdom ETF (EWU), Includes: DBUK, FKU, FLGB, HEWU, QGBR
by: Andrew Hecht

The pound is on an upward trajectory since the January 3 low.

Time is running out - The UK passes the decision to the EU.

The EU may have no choice.

Parliament has nowhere to turn and nowhere to hide.

Kick the can down the road- EWU will rally.

Procrastination appears to be synonymous with politics in Europe these days. The UK went to the polls and voted to leave the European Union in June 2016. The deadline for a deal left plenty of time for the leaders of the EU and UK to make plans and reach agreements that would fulfill the will of the citizens that voted to divorce from the rest of Europe when it comes to economic and political considerations. It is now the month of March 2019. The deadline for a deal is March 29, 2019. So far, the Prime Minister of the UK agreed to a proposal with the leadership of the EU, but the UK Parliament summarily rejected the plan.

Parliament’s rejection was not even close as the membership overwhelmingly voted against the proposal. However, by a narrow margin, they told the Prime Minister they still had enough confidence in her to send her back to the negotiating table to achieve a better deal. As of March 15, 2019, there are 14 short days before the deadline and expiration of the UK’s membership in the EU. No deal would cause a hard Brexit with no agreement over political or economic concerns by both parties. The potential for volatility over the coming days is rising, and we could see it reach a feverous pitch. Both the British pound and stock market in the UK are likely to see lots of price variance in the days leading up to the deadline as procrastination seems to be the only thing both sides have agreed on in recent days. The iShares MSCI United Kingdom ETF product (EWU) holds some of the top companies that trade on the UK stock exchange.

The pound is on an upward trajectory since the January 3 low

The Brexit clock has been ticking since late 2018, and in mid-December, the British pound fell to its lowest level against the US dollar since April 2017 when the currency hit $1.2479 on the continuous futures contract.

Source: CQG

The daily chart of the March British pound versus US dollar futures contract shows that as the clock ticks down to the zero hour on March 29, the pound has been moving to the upside making higher lows and higher highs. The most recent peak came on March 13 after the Parliament voted to rule out the possibility of a hard Brexit. The vote was close at 312 to 308, and it was non-binding. However, the prospects of the uncertainty of a divorce from the EU with no plan, or no understand left the members of Parliament with few choices.

The rejection of allowing the deadline to pass and the chips fall where they may, will lead to another vote on March 14 to extend Article 50. Since Parliament voted against doing a quick a messy exit from the EU, it would only make sense that they will look to continue the period for negotiations beyond the drop-dead date on March 29.

The pound dropped from $1.50 to $1.20 against the dollar in the aftermath of the June 2016 referendum. The British currency is in desperate need of certainty. However, it appears that the currency market would favor the status quo and no Brexit at all.

Time is running out- The UK passes the decision to the EU

Even though the Parliament voted against leaving the EU without an agreement in place and will likely vote for an extension, the final say on extending Article 50 will go back to Brussels and the leadership of the European Union. The EU does not wish to see a divorce without a specific deal in place to address the many issues that will face the UK and the remaining members on the continent and in Ireland. One more than one occasion the leadership has told Prime Minister May and the UK legislative body that they have agreed to what they consider the final deal, and they have no more room to negotiate. The EU is playing hardball with the UK to set a precedent for other members who may consider an exit in the future. The last thing the EU wants to see is a revolving door that could jeopardize the future of the union. Therefore, it may be difficult for them to even agree to more time and could strategically attempt to push the UK to the brink over the coming two weeks. However, when push comes to shove, a hard Brexit would be as complicated and destabilizing for Europe as it would be for the UK. I continue to believe that the two sides will reach some agreement at the eleventh hour, perhaps at 11:59:59 on the final day before the UK’s membership expires.

The UK is passing the decision to the EU, and it could bounce back and forth over the coming fortnight.

The EU may have no choice

Aside from a hard Brexit, there are now three potential outcomes. The first is a deal that would likely come at the latest possible moment where both sides agree to a compromise which appears unlikely. The second is an agreement to extend Article 50, but the UK and EU would likely find themselves back in the same hornet’s nest they are sitting in right now. The only other possibility if the UK Parliament decides to send the decision back to the citizens of Great Britain for a second referendum on either a hard departure from the EU or a remaining within the union. It is also possible that the EU will tell Parliament they will only agree to an extension if the UK holds a second referendum as the EU would prefer, they stay within the confines of the union.

Prime Minister May continues to advocate for fulfilling the will of the British people. However, the initial vote only passed by a razor-thin margin. The bottom line is that there is lots of horse trading ahead over the next two weeks which is likely to cause volatile markets in the UK and Europe and perhaps throughout the world.

Parliament has nowhere to turn and nowhere to hide

It seems to me that the members of Parliament will send the decision on extending Article 50 back to the EU for their agreement. They may also decide that a second referendum is in order. However, the one thing that the elected members of the legislature do not seem willing to do is to make a concrete decision that carries out the result of an election. The people of the UK have put their faith and fate of their futures in the hands of the representatives that sit in the Parliament. In the final hour, they may be forced to make a decision they have avoided or risk losing the faith of their constituents.

If we look at the events of the past months, MPs summarily rejected the Prime Minister’s proposal that she negotiated and agreed on with the EU leadership. At the same time, they gave her a vote of confidence and sent her back to a negotiating table where the other side had no interest in further talks. Now, they voted against leaving the EU without an agreement. The bottom line is that the Parliament has been trying to hide under a rock, but over the coming days, that rock will either disappear, and they will need to make a decision or risk being crushed under the weight of the citizenry that is becoming fed up with the intransigence of their representatives.

Kick the can down the road- EWU will rally

The risk of Brexit over recent months has been a hard exit, and that seems to be off the table unless the European Union forces the issue. The EU is not likely to force a situation that causes economic and political mayhem over the coming two weeks as they already have their hands full with internal economic and political strife. We recently heard from the European Central Bank that lowered their growth forecasts for the Eurozone, and they still face trade issues with the US over automobiles and other exports.

I still favor an eleventh-hour compromise that fulfills the will of the British people, but at this point would not be shocked to see either an extension or another trip to the polls for the UK voters. In either of those cases, the dark cloud of a hard Brexit would dissipate, at least for a while. I am bullish on the pound, and the UK stock market on any price dips over the coming two weeks which could see lots of volatility.

The top holdings of the iShares MSCI United Kingdom ETF product (EWU) include:

Just as the pound has rallied and made higher lows and higher highs since late last year, so have the leading shares that trade on the London Stock Exchange.

Source: Barchart

As the chart highlights, the EWU ETF product that represents the leading shares on the London Stock Exchange have been trending higher, and as the pound, certainty when it comes to Brexit and no hard departure on March 29 is likely to support a continuation of gains. I am a buyer of the pound and the EWU ETF product on any significant dips during the coming two weeks which could be a highly volatile fortnight.

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.

Additional disclosure: The author always has positions in commodities markets in futures, options, ETF/ETN products, and commodity equities. These long and short positions tend to change on an intraday basis.