The past year of how GBP/USD has traded could be characterised thus:
* Sell it on Brexit vote
* Sell it on Theresa May “Hard Brexit” conference speech
* Buy it on govt having to consult parliament on Article 50 trigger after losing court case
* Buy it on rebellious House of Lords
This could be called Stage 1 of the grief that a “Remainer-mindset” market felt after the UK apparently took leave of its senses by voting to Leave.
Then Trump turned up, Article 50 was triggered, and The People had to be heard. As they had said they wanted to Leave, well then, the market had to accept it. GBP/USD then turned into this:
* Don’t sell GBP as the economic data looks good, but wait to sell rallies instead, as the data will eventually turn
* Buy GBP for long-term hedges around 1.20-1.25 as it’s good value
Which led to a fairly narrow GBP/USD range. Until…. Theresa May calls an election! Given the massive lead for the Tories in the polls in the months prior to that decision, and the self-immolation of the Labour party, this could only mean one thing…. She would win, win big, and reduce the risk of a disorderly exit as her hand would be strengthened in negotiations. All that faffing with the court case wouldn’t happen again. The country would be set on its Brexit path. We entered a new phase:
* Buy GBP as Brexit is now going to happen in a “strong and stable” fashion
* Sell GBP if Conservative poll lead wobbles
This is somewhat ironic. Those opposing Theresa May have argued either for a 2nd referendum (the Lib Dems) or less hardline Brexit stance (Labour). Back in Stage 1, the thought of Brexit itself took GBP lower; anyone preventing it took GBP higher. That has now reversed. This is because the market has reconciled itself to Brexit actually happening. The first stage of grief, Denial, has passed.
This means that the default impulse to be short GBP has passed. Indeed, some degree of certainty from Theresa May’s increased mandate, along with the improving economic data, suggests the natural inclination might be for a slightly long position. Or at least a neutral one. Certainly volatility in GBP/USD has been falling:
This opens the way for the Second Stage of Grief: Anger. Once we proceed to June 19th, when the negotiations truly begin, we will see a lot of heat and light from politicians on both sides. Theresa May could go into negotiations with a stronger hand; but David Davis seems to want to use that hand for an early knockout punch, threatening to walk out if the EU27 don’t play ball. The EU27 have been remarkably unified thus far, likely united by the dawning realisation that the UK’s money is coming out of the pot. No-one wants money to walk away without a fight. Hence their obsession with a large headline figure for the divorce bill. Who cares about who gets the cat when you realise you’re not getting the same income?
If the market thought the UK have been irrational, let’s see how they feel about the EU27’s position. If the market still has the mindset of the UK being the guilty party, then EU27 intransigence may be considered more rational than the UK’s.
The point of all of these musings is that the moves in GBP are strongly sentiment driven. It can be no other way, as we are about to enter a period of non-linear political risk. If investors felt that the risks for GBP died with the announcement of the election, they are about to receive a significant shock.