What Hard Brexit?

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Includes: DGBP, FXB, GBB, UGBP
by: Max Loh
Summary

The end-game Brexit scenarios favour the UK, despite Prime Minister Theresa May seeing her second Brexit deal rejected by parliament.

Rejection of her deal should pave the way for a delay in Brexit and a slim chance that a second referendum would take place.

A YouGov poll now shows that if given a chance to vote again, the voting public would choose to remain in the European Union.

Buy the GBP against the USD. It is now trading around 1.32; keep in mind that the currency pair was close to 1.50 levels on the day of the Brexit vote in 2016.

Headlines appear to show that embattled UK Prime Minister had her second Brexit deal rejected by an immovable parliament. That was after she had gone through the trouble to assuage naysayers that her revised Brexit deal had additional clauses that would prevent the UK from being bound to the European Union indefinitely, even in the event that the contentious Irish border issue remains unresolved in the future.

With Brexit set to take place on March 29, Theresa May's deal was rejected by a margin of 149 voters. The only bright spot, it seems, was that the margin of defeat was small compared to her historic defeat in January, where her first Brexit deal was rejected by an astounding margin of 230.

If readers think the future of the UK looks bleak with 2 and a half weeks to go before its official divorce from the EU, I would like to point out that the end-game scenarios for the UK cannot be more favourable right now.

First, a potential hard-Brexit does not possess the shock factor. Going back to the fateful Brexit referendum that caused this utter mess - it was a shocking result, one that the markets were fully unequipped to digest and understand the implications. No one expected the UK public to vote to leave the EU, as there had not been any precedents. This eventually gave way to panic and led to a depreciation in the British Pound by close to 20% against the Greenback from June to December 2017 after the vote.

Since then, the prospects of a Hard Brexit have been considered and ruminated thoroughly by financial analysts and the media for about a good two years. It is arguably ingrained in all investors that a Hard Brexit is likely bad for the UK, and as such, I would venture to say that such a bleak scenario has already been priced in by the markets.

Second, despite Theresa May's second Brexit vote being defeated for a second time yesterday, this actually paves the way for a slim probability of a second Brexit referendum, or at least a delay in Article 50. Today, the UK Parliament will vote on whether they want a no-deal Brexit. Sensibly, there are likely to reject that notion.

If so, on Thursday the UK parliament will vote on whether they want to delay Article 50. This vote will probably pass, as no one sensibly wants to exit the EU without any plan in place. Once Article 50 is kicked further down the road, this paves the way for the UK parliament to push for a second referendum. Interestingly, a poll done by YouGov shows that if a referendum were to be held immediately, 46% would vote to remain while 39% would vote to leave. Simply put, the UK public now wants to reverse Brexit, if given a second chance.

If such a scenario were to take place, would the EU take the UK back? I would venture to say Yes, of course, with open arms. The UK eating humble pie and choosing to reverse their decision to leave the bloc should be a warning sign to the growing Eurosceptic base growing in Italy, Hungary, etc.

I thus suggest the following tactical trade idea to take advantage of a probably Soft/delayed Brexit scenario, with a slim probability of a Brexit reversal. Buy the GBP/USD at market (1.3170) with a take profit target at 1.40 (close to 2018 highs). Keep in mind that the GBP/USD was trading close to 1.50 on the day of the Brexit vote, so a reversal in Brexit could bring the GBP back to those levels. Place a stop loss at 1.27, which gives a wide enough berth to absorb the expected volatility in the Pound in March.

GBP/USD Chart

Disclosure: I am/we are long GBPUSD. 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.