Stuck between a rock and a hard place
Stuck between a rock and a hard place
The main reason that some investors are planning for a politically volatile year for the GBP is because the UK is trying to negotiate two key trade deals at the same time.
The UK is simultaneously trying to agree on trade terms with the EU post Brexit and agree a trade deal with the US. This is no small feat and involves significant uncertainty.
According to a survey, 59% of London investors are looking at restructuring their portfolios in 2020.
So, the UK is stuck between a rock and a hard place in trying to find its way through these two deals.
The problem of negotiating two deals at the same time
Although the UK will have finally left the EU on January 31, and Brexit has happened, the UK still has to negotiate a deal with the EU before December 2020.
Many analysts see this timescale as too ambitious and are expecting the UK to extend the deadline.
Once again, reminiscent of Brexit woes from 2019, if the UK fails to arrange a deal in the timescale then the EU and UK's trading relationship will be a 'hard Brexit' arrangement and exist on World Trade Organization terms. This will be a distinctly negative outcome for the GBP.
On the other hand, the UK has a prospect of negotiating a trade deal with the US. Unlike his White House predecessor, President Trump is keen to support the UK post Brexit with strong trade deals.
However, with the latest issues over Huawei between the UK and the US the tensions that will arise are only too obvious. The UK has allowed Huawei to supply equipment for the UK's 5G network infrastructure, whereas the US fear that Huawei may be involved in US spying for China.
The US may take a harder stance in negotiating with the UK over this Huawei issue. Furthermore, President Trump is prone to unpredictable moves in his negotiations and that level of uncertainty is a further factor that unsettles investors.
Brexit and the fear factor
From the onset of Brexit, financial investment has been held back from the UK over uncertainty. Companies have held back expansion, overseas investors have held back spending in the UK, and large companies have either moved or planned to move their Headquarters.
This 'uncertainty' is the first impact of trying to negotiate two deals together. Financial markets don't like uncertainty as that equates to risk. As long as there remains two trade deals for the UK to negotiate it is expected the 1.3500 level to be the near-term cap in the GBPUSD pair.
The importance of a good deal with the EU
The UK's largest export partner is the US with, according to the World Economic Forum, around 13.39% ($59 billion+) of the UK's exports. However, nearly half (45%) of the UK's exports go to Europe
A look at the table from the UK's Office for National Statistics below outlines the UK's export market and the large proportion of exports heading to the EU. £235.8 billion of the UK's export market heads to the EU.
On the other hand, £318 billion of imports comes from the EU. It is therefore very important that the UK gets a good deal with the EU.
The impact on the financial markets
•A delay to the EU-UK trade deal
This will result in a positive boost for the GBP, simply because a delay means that the UK will not have to trade with the EU on WTO terms. If this was to be announced, expect a retest of 1.3500 on the GBPUSD pair
• A positive agreement on EU-UK trade terms
This would be a great result for the GBP and I would expect a test of 1.4200 over the coming weeks
following an EU-UK trade deal. This would remove virtually all uncertainty over Brexit
•A UK-US trade agreement
Any significant increase in the UK and US trade relationship would be positive for the GBP. How positive would depend on the detail and this is the most unknown factor that the market would have to price.
•An EU-UK trade agreement and US trade agreement.
This would be the best result for the GBP and I would expect a strong bid into the GBP and the FTSE.
With both the GBP and the UK equity market being undervalued, due to trade risk concerns, there remains great opportunities for short, medium- and long-term investments in the GBP and the FTSE in this environment.
Possible approaches to trading these events
1.Trade the ups and downs of the latest news. So, for example, you hear of positive EU-UK trade terms from the ECB's president, then expect sudden GBP buyers. Conversely, you hear that the ECB President says a deal can't be done this year, expect GBP sellers. Go with the short-term flows.
2.Trade the big picture. If over the long term, you think that the UK will eventually strike a deal then buy UK stocks or the GBP as an investment. Perhaps the deals will take 2 or 3 years, but by getting in now you are in early and stand to profit once everything is sorted. Of course, the risk is that the deals don't happen. Unlikely, but as I often say, unexpected events can and do occur in the financial markets. There are no 'dead certain' bets and so risk must be managed every single time.
This article was submitted by CMS Prime
