Morning Brief – Tuesday 30th

Submerged Sterling

All hell was breaking loose in financial markets yesterday whilst Johnson was visiting a submarine in Scotland. Photographed inside the control room, a stern-faced Boris couldn’t have done much more to develop the perception of his war-cabinet and his hard nosed government. Okay, perhaps firing one of the missiles at Brussels to show he meant business would’ve surpassed the photographs and, come to think of it, been a classically self-defeatist Borisovian move – perhaps another time!

Whilst Boris played battleships his spokeswoman, Alison Donnelly, reinforced the concern of a no deal that has plagued financial markets since his appointment first seemed imminent. She confirmed the Prime Minister’s belief that meeting with his European counterparts and members of European institutions was futile until such point as they signalled a willingness to renegotiate the deal that Theresa May had secured. Given explicit warnings from European leaders and negotiating representatives that no such thing is possible, Sterling traders and investors continued to exit the Pound in anticipation of a hard break from the Union driving its value through the floor.

Game Theory came into play today in financial decision making akin to a simple game of chicken: two cars drive down the road towards each other – pull away whilst your opponent remains steadfast and you lose; both steer away and you’re both humiliated but at least alive; crash and you’re both hard as nails but dead. Now studying economics will teach you there’s a way to win this game: to credibly convince the other that your hands are tied: you’ve no choice but to continue straight no matter their actions. Boris’ handcuffs will be his cabinet and whilst a pack of Brexiteers (the formal collective pronoun for such a bunch I’m sure!?) might be met with criticism by some I think it’s damn brilliant as a strategy. “My Hands are tied Mr Barnier; Mr Juncker; Mrs Merkel; Mr Macron” (yeah you get the idea), “my government would never let me back down”.

Sadly the EU has its own handcuffs. 27 people representing nearly half a billion people stand behind a negotiator with a mandate to speak for them. Show me a tighter constraint, I challenge you! Now what happens in our game of chicken contenders if both are credibly constrained? A big fireball that, in this case, involves the UK crashing out of the EU on 31st October without a deal pursuing a scenario which many analysts believe could spell GBPUSD, let alone GBPEUR, parity.

With 93 days left until the incumbent legal Brexit deadline, you can understand why few investors want to be long Sterling given the risks surrounding its political and economic outlook. Today, for the first time, the implied volatility demonstrated by options markets for 31st October resembles how it looked surrounding 29th March. Markets are starting to believe Boris’ car is going straight on then, but will the EU share that opinion and deviate? Let’s hope so and, with summer holidays in full swing, let’s hope soon! Silver lining: CFTC data on Friday confirmed that net positions betting on Sterling’s decline had grown in number and volume increasing the possibility that a shift in sentiment could force a sudden liquidation and violent upward spike in the value of the Pound. If the EU flinches, we could see just that.
 

Discussion and Analysis by Charles Porter

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