Of course Brexit means that something is wrong in Europe. But Brexit also means that something was wrong in Britain. – Jean-Claude Juncker
With October 31st just around the corner, all eyes are on the British Pound (GBP) and how it’ll react to the Brexit deadline. Three years and a few months after the United Kingdom voted to leave the European Union, uncertainty remains.
We don’t know if the United Kingdom will ask for a deadline extension again. After all, it did it once, so why not do it again?
In the meantime, the United Kingdom's economy is not doing great at all. Many jobs and companies left the country unsure of what the future will look like.
As I argued in one of the recent Lead-Lag Reports, lack of clarity around Brexit is causing UK households to become anxious. However, UK equities have performed well of late as a weaker pound helps the export-focused equity market.
We do know one thing. The consensus is that the GBP will suffer. If the initial reaction on the Brexit vote was a sharp selloff across the board, the GBP should weaken some more when Brexit happens. Right?
But trading isn’t that easy. If it was, you’d probably have no need to read this article but travel around the world in your private yacht.
I'm not arguing here for a stronger GBP in general, but a stronger pound against the Euro. That's right, this article offers a bearish perspective on the EURGBP cross, despite consensus seeing it higher. Here's why.
The Fed's first cut in a cycle used to be a reliable indicator of how to trade the EURGBP. It all starts with the Bank of England. It would have to ease policy, and recently the most hawkish MPC member, Michael Sounders, admitted he's contemplating easing no matter the Brexit outcome. As it turns out, the Bank of England usually follows suit when the Fed starts cutting.
That's bearish for the pound, but let's not forget we live in a world where central banks race to cut rates. While the Bank of England will cut from 0.75%, the ECB is well below zero and has QE in the pipeline.
History tells us that EURGBP tends to pick-up after the first cut from the Fed. Since 1984, it did just that on six occasions. Only in 1987, the EURGBP traded lower five months after the first cut from the Fed in a cutting cycle.
But history doesn’t consider Brexit. Since the 2016 referendum, the EURGBP hesitates to move higher. Many argue for parity, but a bearish triangle formed on bigger timeframes impossible to get unnoticed.
Bulls will argue that this is a continuation pattern. It may very well be. But a bearish scenario calls for the triangle to break lower and to act as a reversal pattern. When it happens, the last swing higher pierces the opposite trendline, just like the EURGBP did recently.
How to play it? A break below 0.85 opens the possibility for the entire Brexit move on the EURGBP cross to be retraced. Yes, back to 0.76 with a tight stop-loss.
Is it 1987 all over again? I guess we’ll find out soon enough.
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