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Any significant progress in the trade negotiations is being hindered by the fact that following the last round of US tariffs the Chinese side will struggle to believe that the US administration is a reliable negotiating partner. Without a certain degree of basic trust, negotiations tend to be long-winded and difficult. In particular, as successes are going to depend on whether the US President considers these as conducive towards the applause of his followers or whether he believes instead that his fans would appreciate it if played the “tough guy”. There are reasons supporting both views. One day one view seems more convincing; the next day it's the opposite view. That means the fickle approach of the US side is systemic and cannot easily be corrected.
Like most mortals, we have no insight on how the long-running Brexit drama will resolve.
After yet another night of drama, we have seen the bill to prevent a no-deal Brexit go through the three initial readings in the House of Commons in double-quick time and a failed attempt by the government to trigger a general election. Yet the headlines in the tabloid press this morning suggest that opposition leader Jeremy Corbyn is the villain of the piece as he refuses to take the bait of an election. There is an old joke that the only difference between the UK and a banana republic is that the UK is not a republic and it doesn’t grow bananas. But the jokes are starting to wear thin.
All we can say with a modicum of confidence is that should the UK crash out of the EU without a deal, currency markets stand a good chance of directionally reprising the price patterns observed in the aftermath of the 2016 referendum. EURUSD fell 1.5% in the 3-months following the shock result and a more substantial 8% in 6-months; EURGBP climbed north of 10% over this period, much of it on the day of the vote; and the realized correlation between the two fell to as low as -90%. Yet EURUSD vs EURGBP 3M implied correlation today is marked at +14%, Euro has an independent bearish catalyst at play in the form of potentially ECB easing including QE in September, and the pricing of bearish Euro options is sweetened by multi-year highs in forward points. Hence, consider the following as no-deal Brexit trade:
3M (EURUSD < 1% OTMS, EURGBP > 2% OTMS) costs 11% (individual digitals 26% and 34.7% respectively). Courtesy: JPM & Commerzbank
