FxWirePro: Speculation on soft or hard Brexit still lingers - Sterling and UK equity basket wary of UK divorce pact with EU

Almost three quarters after the UK began the Brexit proceedings, the terms of divorce majorly seem to be steady. The UK and the EU would now move on to negotiations for a transition period and future UK-EU trade. These must be finalized by October 2018 to give the EU27 six months to indorse any deal.

The EU27 looks set to give the green signal to enable Brexit negotiations to move from ‘divorce’ issues to the next stage on a transitional period and a new relationship. German Chancellor Merkel said that UK PM May “has made good offers, which might make it possible for the EU27 to see sufficient progress”.

While in the UK, the Times reported that the government is expected to back down from writing into legislation the Brexit date of 29th March 2019, which is perhaps another sign that the probability of an orderly departure has risen.

EU leaders likely to agree for the Brexit talks into their second phase, eyeing on the UK to provide more clarity on the sort of deal it wishes for. While arriving for the second day of an EU summit in Brussels, Jean Claude Juncker, the president of the EC, hinted that negotiations on the future relationship would begin “as soon as possible.”

He appended his expressions of support by European leaders for Theresa May on yesterday, after she lost a key domestic vote on Brexit, and warned rebel members of her party of the perils of striking a future EU deal down.

Cable seems to remain in range-bounded trend, between 1.3300 pivot support and the 1.3550 reaction highs set at the end of November.

Further range trading is expected. Breach below 1.3300 supports likely to eye at 1.3100-1.3050, on the contrary, anything above 1.3550 resistance may see 1.3650 - 1.3680 mark.

This is all within a medium-term range that we expect to remain intact in the coming month(s) between 1.28-1.26 support and 1.36-1.39 resistance.

In a broader perspective, our analysis indicates the bearish trend that started back in 2007 at 2.1160 is in its last sphere. The recent price action enhances the chance that 1.1490 was a major long-term low. Even so, there exists an element of risk of sharp sell-offs on any negative Brexit news.

The outlook for UK equities in 2018 is likely to be increasingly shaped through the Brexit lens. So far in 2017, we note that the FTSE100 is the worst-performing index among the most widely used global equity benchmarks year-to-date, despite the backdrop of positive growth revisions. 

Comparing volatility across different UK assets yields an interesting view of how different asset classes have been behaving.

Firstly, the current dispersion in equity, rates and FX volatility levels seems elevated by historical standards. More specifically, FX volatility has remained at around average levels over the last five years while rates volatility is currently more than two standard deviations below average levels. Equity volatility is at around one standard deviation below average levels.

Secondly, this dispersion seems to validate the standpoint back in June that FX would tolerate the brunt of Brexit, while equity volatility would remain subdued in sympathy with other equity indices globally.