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Brexit Day Arrives: Why One Trader Thinks It Will Lead To A “Hefty Rally” In Sterling

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With Theresa May’s signed Brexit exit letter due to be delivered in just over an hour to Europe, “severe risks to the U.K. economy litter the path ahead” but as Bloomberg’s Mark Cudmore writes overnight “this isn’t the time to trade on them.” Instead the former FX traders lookat flows, and specifically the record speculative sterling shorts, and notes that “at some point, these positions have to be unwound” adding that “after Brexit is officially triggered, there are no other concrete dates on the horizon for bad news, so many shorts will be closed.” His conclusion: “As a result, from Thursday, it’s logical to assume that the dominant flow in the coming weeks will be pound purchases. That could lead to quite a hefty rally.”

Indeed, after sliding below 1.24 yesterday, sterling has already staged a modest rally overnight. Will it continue is unclear, but in a market in which the news leads to covering of excessive outlier spec positions, we tend to side with Cudmore on this one.

Here is his full note:

Brexit Trigger Is a Time for Traders to Glance Up

 

The day has finally arrived. Severe risks to the U.K. economy litter the path ahead, but this isn’t the time to trade on them. 

 

It’s always important to differentiate between asset pricing and the economic outlook. They are clearly connected but, importantly, any correlation is discrete in nature rather than continuous, and the lag is jumbled and inconsistent.

 

The U.K. economy keeps confounding the doom-mongers. It may continue to do so but, once Article 50 is triggered, it becomes very vulnerable to any hints of an acrimonious hard Brexit from the EU.

 

That must worry everyone who trades U.K.-related assets. However, it doesn’t mean they should sell upon the official trigger — it means they probably did already as they’ve had months of warning.

 

This will be like knowing you’re going to be pushed off a cliff edge, preparing for the worst, and then landing on a ledge just below. It doesn’t mean you won’t ultimately plummet to your death, but there’s the relief of an unexpected opportunity to save yourself. You’d already fully prepared for the drop so this is a moment to instead consider if there’s any way back up rather than repeat your preparation for the fall.

 

The data shows that speculative sterling shorts are at a record. At some point, those positions have to be unwound. After Brexit is officially triggered, there are no other concrete dates on the horizon for bad news, so many shorts will be closed.

 

As a result, from Thursday, it’s logical to assume that the dominant flow in the coming weeks will be pound purchases. That could lead to quite a hefty rally.

 

This won’t be a sign from markets that Brexit will be wonderful. And, in fact, sterling appreciation would make the economic future even tougher.

 

There’s a perilous journey ahead but, at least for now, the potential path upwards deserves more consideration and focus than the downside option



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