The Brits are officially leaving the European Union (NYSEARCA:EU), following the invoking of Article 50 and British envoy Tim Barrow handling a letter to the EU Council on the 29th of March 2017.
An informative book on the subject is explored by Roger Bootle of Capital Economics, and I've found it to be highly instrumental in highlighting Britain's options and her role in a post-Brexit Europe.
As laid down in Article 50, they have until end-March 2019 to finish the negotiation process and formally divorce from the EU. That means the Brits have 22 months left as of the time of writing.
Here's the list of prickly and thorny issues that the UK and the EU have to discuss and agree on:
- The 'Brexit Bill': the cost that the UK has to fork out to the EU for the divorce
- A viable commercial relationship in goods customs between the UK and the continent (highly complex)
- A viable commercial relationship for the European services' sector between the UK and EU countries
- The rearrangement of 'passporting' licenses for the financial services industry (a big driver of growth for the City)
- Immigration agreement between the UK and the EU (quotas, etc)
- The Great Repeal Bill: to place EU law onto the UK statute book (a domestic issue)
- A potential Scottish Referendum? (a direct challenge to Whitehall)
- The citizenship rights of Northern Ireland citizens (another thorny domestic issue). Currently, NI citizens can hold British and Irish citizenship under the Good Friday Agreement. Would there be a re-igniting of a 'border poll' on reuniting Ireland?
It isn't difficult to acknowledge that even the most hopeful optimist would acknowledge that it is a very tall order to cover everything (much less to even reach an agreement) within 22 months. Even the German government publicly mentioned that the timetable is "damn narrow". Every affair regarding political, legal and commerce is on the table. The issues are tenacious and tricky, and there are many unknown spanners that could be thrown in to derail talks and potential settlements. What makes this situation a potential 'time-bomb' is firstly, the willingness of UK politicians to stick to this 22-month timeline for Britain's departure even if no settlements have been made (literally for better or worse), and secondly, the willingness of EU policy-makers to dish out severe exit terms to the UK, in order to deter other EU members from leaving the union.
It remains the subject (whether the UK will be prosperous after departing the Union) of discussion among economists and intellectual circles, but as global macro traders, we only need to know a few facts.
(NYSE:I) The Euro is momentarily weighed down by political concerns, as the bogeyman of populist politics haunts over the EU and as pundits and speculators continue to forecast the inevitable demise of the monetary union as we know it.
(II) The complex realities of the Brexit negotiations are relatively bearish on the British Pound's prospects.
Should the EU survive this year's round of populist assaults and the incumbent politicians unite further to ensure that the Union survives, the political risk premium on the Euro currency and European asset markets will diminish accordingly. In fact, with the victory of pro-EU centrist candidate Emmanuel Macron over his far-right rival Marine Le Pen in France's presidential elections, the financial markets have reacted positively, with the next high-key political event the General Elections in Italy in 2018 (if the German Federal Elections go smoothly). The renewed EU this year will have much leverage and negotiation power over the UK.
Market participants are likely to shift their focus back to economic data in the British Isles and the European continent, and there is a potential for the European economies to play catch-up with the UK given that they clearly are in the earlier stages of the business cycle as compared to their British counterpart.
With President Mario Draghi of the European Central Bank (ECB) acknowledging on 28 April that economic momentum has picked-up but inflation not yet so, he is laying the foundations of a tightening in monetary policy in the Eurozone. The central bank is expected to dwindle down its current asset purchases, and markets have not priced in a further upward move in interest rates among the core-EU countries yet. What matters is how domestic spare resources and downward forces on inflation diminish over the next few months and quarters, forcing the ECB to change its hand and alter the current policy path.
A simple regression analysis done between the Bank of International Settlement's (NASDAQ:BIS) Euro Real Effective Exchange Rate (OTC:REER) against the total amount of the ECB's balance sheet amount reveals a loose fit between the 2 variables, with their R^2 reading increasing post-2010 alongside its negative correlation. A potentially more-hawkish ECB that's preparing to tighten monetary policy will clearly boost the Euro's relative strength against all of its trading partners.
On the other hand, a hectic Brexit may force the Bank of England (NYSE:BOE) to withhold from withdrawing easy accommodation for their monetary policy. This could happen if a slowdown in EU-migrants into Britain show up in challenges faced by businesses in the UK. Thus, the likelihood of an increase in a divergence in monetary policy between the UK and the European continent will drive the relative pricing of asset markets there.
This means that there is a possibility of a narrowing of interest rate differentials between the UK and the Eurozone possibly towards the end of 2017 and in early-2018, providing a tailwind for the Euro's relative strength against Sterling, as Britain enters the later stages of the business cycle and as British politicians struggle with cross-channel negotiations with Brussels.
On the weekly price charts of the EUR/GBP currency since 2008, we can easily see the Euro's appreciation against the British Pound since the fated Brexit vote in the summer of 2016:
The pair is clearly in an uptrend, with the 50 and 100 week moving averages crossing above it's 200 week moving average:
The pair has been in a range between 0.836 and 0.880 since the start of 2017 (it looks like a bull pennant on the weekly chart above), with a potential support level at 0.83. Should the pair breach above 0.8658, which is 78.6% of the the entire upward move from July 2015 to October 2016, the pair could rally to above 0.880, providing a nice long entry position.
Don't get me wrong, the Euro on an absolute basis is an incredibly flawed currency. The viability and survivability of the EU project remains under question for many good reasons. It will continue to haunt Europe's policy-makers into the distant future. But as of the current juncture, we as macro speculators work with the facts as we see it now, that the EU has much leverage and negotiation power over the UK, and based on that, we have an opportunity here to bet on the relative dynamics between the EU and the UK...
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in EUR/GBP over the next 72 hours.