FX Update: USD & JPY surge as sterling traders face two-way riskSummary: The US dollar and Japanese yen surged yesterday, on possible sudden safe haven seeking within G10 on the recognition that the short-term two-way risks for sterling are significant ahead of the Brexit negotiation deadline tomorrow. GBPUSD plunged back below 1.3000 but depending on how headlines shape up tomorrow on the status of negotiations could find itself at new multi-month highs or lows by Friday.
Trading focus:
Pronounced risk for GBP volatility through tomorrow
Yesterday failed to produce any positive headlines as negotiations between the EU and the UK continued ahead of the October 15 deadline tomorrow that Boris Johnson has declared for making a deal. An EU Summit also starts tomorrow and ends on Friday. Sterling was weak yesterday and weaker still this morning, led by GBPUSD on the added factor of a USD bounce-back, as the reversal well back below 1.3000 there likely triggering stops on recent long positions.
There are notable two-way risks for GBP here if the two sides are unable to come to basic terms tomorrow – and the market doesn’t look ready for bad news for sterling. On the other hand, headlines touting a sudden breakthrough in talks that point toward “entering the tunnel” (when the two sides have agreed in principle and begin the process of hammering out the details) would likely provide a very meaningful GBP boost. UK Prime Minister Boris Johnson and EU Commission President Ursula Von Der Leyen are to speak today.
Keep in mind that it is still possible to cobble together something before December 31 even if the UK side pulls out of talks after tomorrow in a bid to up the pressure for last ditch talks in November or even December. On that front, any negative sterling reaction tomorrow on a stand-off could be sizable but then stop suddenly and even reverse partially on hopes of a new round.
Also keep in mind that there are a spectrum of outcomes on December 31 from a comprehensive deal that is surprisingly generous to the UK’s financial services industry (unlikely) to a more or less “no Deal” outcome that only sees modest mitigating measures to avoid the worst types of disruptions (not at all priced – perhaps a 25% probability however?). The most likely outcome is some sort of hybrid deal that is more or less a free-trade deal on goods with reduced access/passporting into the EU for UK financial services. That leaves the key questions of the knotty fisheries issue and more importantly, whether the two sides can agree on the framework for adjudicating whether UK “state aid” aimed at favouring domestic industries and companies exceeds what the EU is willing to tolerate. The UK clearly wants significant state aid leeway while the EU has sounded more flexible recently on fisheries.
Chart: GBPUSD
Breaking: In the seconds before pixel time we get the headline that “the UK signals that it won’t walk away from EU talks immediately”, thus enhancing the risk that we are none the wiser in either direction on tomorrow’s deadline if the two sides have yet to reach agreement. GBPUSD reversed badly yesterday and into this morning on the combination of sterling weakness and USD strength as we reach crunch time for this phase of Brexit negotiations ahead of tomorrow’s deadline established by Boris Johnson, a day that also marks the start of a two-day EU ummit. The move back well below 1.3000 likely triggered stops on fresh longs, but given the binary implications of the different headlines that might hit the market tomorrow, the technical implications are irrelevant. Safe to say that we could be at a very different level on Friday’s close – as low as sub-1.2500 on a complete collapse of talks to as high as perhaps 1.3500 on the most promising version of possible outcomes.
The US dollar resurgent – but so is the JPY ahead of US election uncertainty.
The US dollar and the Japanese yen both surged yesterday, with the immediate trigger for trading clearly the release of the US September CPI data yesterday, which was fully in-line with expectations and failed to immediately buttress the weaker USD argument linked to the risk of increasingly negative real rates. The development boosted the yen as well from the angle of long US rates, which backed down sharpy yesterday as well, as the yen is often supremely sensitive to long US yields. The tactical technical developments look short term bullish for both the USD and the JPY in many crosses, but very choppy charts and the looming US election (and potentially considerable volatility from the Brexit situation noted above in the coming sessions in particular) make it tough to hang our trading hats on strong directional moves over the next two-three weeks.
John Hardy
Head of FX Strategy
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