FxWirePro: Geopolitics Engulfs GBP/USD - Bearish Tail Risk Hedge via 2m Put Spread

At the request of Prime Minister Boris Johnson, Queen Elizabeth II will prorogue Parliament from 9th September at the earliest and 12th September at the latest. On 14th October Parliament will then resume a new session with the Queen’s Speech. Initially, Sterling eased significantly but was able to recover slightly intraday. At first glance, the latter might surprise, as the step, which critics have branded a “constitutional outrage”, shortens the time MPs have to prevent a no-deal Brexit. However, just like everything else in the Brexit process, things are not as easy as that.

That is partially due to the fact that Johnson is keeping his cards close to his chest. It remains completely unclear what he is trying to achieve with this constitutionally contentious steps. Of course, nobody believes that he is taking the step merely for reasons of domestic policy, regardless of the imminent Brexit, but a GBP positive interpretation is possible.

However, the news around PM Johnson’s meetings with Merkel and Macron ahead of G7 were closely watched this week but delivered little new information. Prior to the meetings, PM Johnson released a letter to European Council president Tusk, proposing to replace the Irish backstop with a commitment to put in place “alternative arrangements” before the end of any transition period.

The content was nothing new relative to comments Johnson has already made on rejecting the backstop, although our rates strategists note that the wording that post-Brexit laws and regulations of the UK “will potentially diverge from those of the EU” is harder than the post-Brexit relationship May had sought. The subsequent meeting with Merkel was viewed by some as indicating a softer stance from Germany, but our economists note that her comments did not indicate that she was open to changes in the WA and that the onus was on the UK to come up with solutions (within 30 days). Macron as expected took a harder line. It is highly unlikely in our view that the EU will reopen negotiations on the Withdrawal Agreement and will not accept Johnson’s proposals for the Irish border using alternative arrangements based on mutual recognition. The expectation is for Johnson to blame the failure of his attempts to renegotiate on a lack of cooperation from the EU once parliament reconvenes in early September which should see risks of FX market pricing in greater odds of no-deal in September as a clear path to blocking this path through parliament won’t be immediately obvious, even as no-deal rhetoric steps up.

Trade tips: Stay short a 2M GBPUSD 30d/10d bear put spread at the beginning of August (spot reference: 1.2152). Paid 0.66%. Marked at +0.42% Courtesy: JPM & Commerzbank