Theresa May will trigger Article 50 on Wednesday and officially begin the process of leaving the European Union. The murky and opaque nature of the Government’s proposed plans and strategies should leave us weary of the unknown unknowns. However, even if it may be difficult to see the wood for the trees, the subsequent impact on Sterling and UK financial markets is certainly worth commenting on.
Our view: Sterling
Many commentators have simply stated that Sterling will be volatile and could sell-off. However, we aren’t so sure that this will bear out in practice and believe it is possible that we may in fact see a resurgence in Sterling.
Sterling sold off considerably following the referendum result, but has displayed some resilience recently, particularly against the Dollar which has suffered a blip due to President Trump’s failure to repeal Obamacare.
Numerous Forex trading houses have highlighted that Sterling is one of the most heavily shorted currencies in the market, leading us to question whether there are substantive new market entrants available to push the price even lower, thus the predicted heavy falls may not actually prevail.
Our view is that although Sterling may fall in the short term due to further risk-aversion trades, in the long term, as ‘facts’ come to light, Sterling will likely pick up as market participants display the “sell the rumour and buy the fact” mentality. Investors look to be positioned on the premise that we are approaching a hard Brexit, and on the proviso Theresa May’s discussions receive a mostly positive press, we feel that Sterling should display some resilience and could strengthen.
Although we expect Sterling to strengthen, we think it is unlikely to return to pre-Brexit levels – the IMF’s pre-Brexit analysis has shown that the Sterling Real Effective Exchange Rate was overvalued by approximately 18%.
Our view: UK financial markets
The lack of a clear political message regarding Brexit negotiations has served to undermine investor confidence and the impact of Brexit on corporate growth prospects remains unclear (particularly the impact on the large financial sector in London).
That being said, we often view the market as being like a child; it doesn’t like surprises … Investors have known about Brexit for a long time now, so you have to wonder whether it will have the impact that some people are dreading.
In conclusion, one has to question whether the pessimists have been given too much rope with which to hang investor, post-Brexit, confidence.