If the past four years are anything to go by, then the next few months should be quite an interesting and volatile one for UK assets. The transition period between the EU and UK is set to end on December 31st, and without any sort of trade agreement, the UK will end up trading with its biggest trading partner on World Trade Organisation terms. The issue, however, is much deeper than just the trading relationship. The UK and other members of the EU have been closely aligned for several years on a variety of levels, which means that a ‘no deal’ Brexit could result in great uncertainty and chaos. Both sides are striving to reach an agreement within the next few months, but this has not been made easy by the latest developments from the UK side.
This week, the EU and UK negotiating teams are meeting for the next round of talks. However, over the weekend, comments and actions from the UK government have made talks that much trickier. The UK has set out legislation on how the UK internal market will function after this year, but certain parts of this legislation will legally override sections of the Withdrawal Agreement negotiated last year. A UK minister has even gone as far as admitting that this legislation would break international law, yet the government seem set to move ahead with it. The legislation has been met with concern both in the UK and the EU, but EU leaders remain determined to try and reach a deal.
Adding further to the difficulties, Boris Johnson has set out a deadline of 15th October for an agreement to be reached. He has stated that if a deal cannot be made by this date, the two sides should ‘move on’. An interesting point to note here is that he has not explicitly threatened that the UK will walk away from negotiations after this date. This seems very much like a negotiation tactic, although it is unlikely to be effective. The October deadline will probably be breached, and talks are likely to drag on until late-November.
Considering the current circumstances and economic conditions of both the UK and the EU, neither side can afford a no deal Brexit. As such, I believe a basic agreement will be made late in the day, and the two sides will continue to add to the agreement in the coming years.
In the markets, we are likely to see Brexit-related volatility returning for the British pound in the coming weeks. As negotiations drag on, the market will need to consider the possibility of a no deal Brexit. In my opinion, at current levels on GBPUSD, it does not seem like the markets are pricing in the possibility of a no deal Brexit, which means that current prices are attractive for building short positions.
If negotiations remain at a stalemate, volatility in the pound is likely to pick up in the coming weeks, and we could revisit some of the levels hit earlier this year in pound pairs. A no deal scenario would likely see the pound collapsing to historic prices, with the UK economy probably experiencing a double dip recession, along with the possibility of the breakup of the union. On the other hand, if an agreement were reached, we could expect to see some limited upside for the pound. Regardless of what happens, the next few months for the pound should give us some high-quality opportunities.