Sell GBP/CNH on rising Brexit uncertainties - ANZ

Analysts at ANZ note that the European Parliament (EP) recently published a resolution on the state of play of negotiations with the UK, which will be voted by the Parliament next week (3-4 October). 

Key Quotes

“This resolution states that there hasn’t been ‘sufficient progress’ in the Brexit talks. While the Parliament itself has no formal role in the matter, this decision will feed into the official EU summit’s vote later in the month (19-20 October); and we see little chance the EU leaders will contradict the Parliament’s resolution. This will have a number of potential consequences:

• Without a judgement of ‘sufficient progress’, the EU’s negotiators won’t be allowed to start negotiations on either a transition period or the future trade relationship; rather, they will stay focused on the three key issues of citizens’ rights, the ‘Brexit bill’ and the Good Friday Agreement.
• On these issues, we believe the stance of EU and UK officials remain too distant to allow the two parties to significantly advance in the negotiations, especially in such a short time frame. This is an issue because, while the EU Chief negotiator, Barnier, has welcomed the ‘constructive and more realistic tone’ from PM May’s speech in Florence, he has repeatedly argued that the PM’s words need to be translated into concrete actions. He recently reiterated that ‘sufficient progress’ hasn’t been achieved yet; while he also explicitly ruled out the possibility of transition-deal talks until the divorce bill, citizens’ rights and Northern Ireland are dealt with. This same position has been shared by a number of leaders across the European Union, including French President Macron, German Chancellor Merkel and the EC President Tusk. It is also the same position that is expressed in the EP resolution.
• We believe that while reaching a compromise quickly is a priority for the UK (which is expected to leave the EU in March 2019), timing is not such a big issue for the EU, as the latter is rather focused in allowing for a deal that would not compromise the future of the European project. On this front, only the threat of a tough and uncompromising EU is likely to be enough to sufficiently reduce the chances of other countries departing in the future.
• As such, we believe that a judgement of ‘insufficient progress’ is the most likely scenario next week, with the negotiations around both a transition period and a trade deal likely to be postponed to December at best (when the EU Council will meet again after the October meeting). Political uncertainty in the UK may also rise next week as speculation is increasing around PM May’s future as the party leader. This follows claims that a number of Tory MPs are willing to sign a letter challenging her leadership at the Conservative conference this weekend.
• We think that the GBP is vulnerable to disappointment. Our PCA-residual model, which highlights the deviation of any given currency from the movement of broad market drivers, showed that after Brexit the idiosyncratic weakness in the pound reached a record low. No other event in the past twenty years has driven as much independent weakness for the currency. However, observing the behaviour of this residual over the past few months shows that all of this idiosyncratic weakness, which can be thought of as the Brexit premium, has been completely unwound.
• As the market digests the further rise in uncertainty, we see the potential for some near-term weakness in the GBP, and we recommend tactically selling it against the CNH. Chinese authorities are signalling they don’t want yuan to weaken too much from current levels, meaning the CNH is likely to trade steadily. Further, from a technical perspective, the cross looks to have topped out near the resistance level (just below 9) and is due for some tactical retracement. We recommend selling the cross with a target of 8.66, and we will reassess the trade at 9.00.”