Volatility elevated ahead of May's Brexit speech; Pound recovers

17 January, 2017

It’s Sterling’s day.

Financial markets are anxiously awaiting U.K.’s Prime Minister Theresa May speech later today where she will lay out a detailed divorce plan from the EU. Lot of reports were leaked since Sunday on what to expect her to say, and the most interesting part is that she has no interest in partial departure which suggests we’re heading towards a “Hard Brexit”. Traders were very fast to react, sending the pound 1.6% lower on Monday to trade below 1.20. However, the recovery in early Asian trade Tuesday indicates that lot of the bad news are already priced in, and for the pound to fall substantially lower it requires more than just signs of a hard Brexit plan.  

If the Supreme court decided that May needs to secure the consent of Parliament before triggering article 50, potentially delaying Brexit for couple of months, this is likely to provide sterling a boost by unwinding many short positions. Traders should be aware that sterling won’t be a one way play and volatility could be elevated to extreme levels.

On the data front, UK CPI is expected to hit 1.4% in December, up 0.2% from November and 0.5% from October’s reading. This will not only mark the highest inflation rate since mid-2014 but the pace of inflation escalation is pulling U.K.’s real interest rates even lower.  Of course, this is going to be a challenge for the BoE, but if it indicates anything, it’s interest rates next move is only upward, leaving monetary policy with very few options to support the economy if needed.

The safe haven Yen is the major beneficiary of the heightened uncertainty over U.K.’s Hard Brexit scenario and Trump’s policies. USDJPY has fallen for the seventh straight day, and declined by more than 4.3% from January 3 peak. The fall in bond yields worldwide will continue to lend some support for the Yen, but whenever this trade is over I expect the Yen to weaken again.

The U.S. dollar is falling against all its major peers with the index dropping below 101. There’s no fundamental reason for the selloff and I don’t think the dollar’s rally is over yet, but the “Trump trade” has clearly cooled down in the past couple of days as markets still have many answered questions regarding future fiscal policies. Let’s hope we get some answers on Fridays inauguration. 


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