The trigger of Article 50 is the event traders have been waiting for since the U.K. voted to leave the European Union. Yet as Prime Minister Theresa May approaches her end-March deadline for launching Brexit, there is no consensus on what it means for markets.
The pound has slumped 18 percent and the country’s benchmark equities index has rallied about 16 percent since the June 23 referendum. While currency and stock volatility is now calmer ahead of the talks, some analysts are warning markets are too complacent in expecting a smooth path toward an agreement.
Is Article 50 already baked into sterling?
No, says Bank of America Merrill Lynch. “We reject the notion that sterling has fully priced Article 50 and beyond. Risks to the currency remain to the downside on a disruptive start to negotiations,” strategists including Kamal Sharma said in a note to clients on March 2, adding they see a dip before a recovery into the end of the year.
JPMorgan Chase & Co. is also bearish. It recommended on March 3 selling the pound against the dollar at 1.2250, with a stop at 1.2530, as it sees the currency as the most over-valued in the Group-of-10 and investor confidence as vulnerable.
Bank of America’s preferred strategy is to bet on greater swings in the pound, rather than its direction. It has recommended buying three-month forward volatility, a measure of expected swings, with a target for it to gain around 20 percent from current levels. Societe Generale SA also sees opportunity in options, as it expects two-month implied volatility to pick up if cable falls below $1.20.
Meanwhile, Morgan Stanley is more sanguine and thinks the triggering of Article 50 shouldn’t come as a major surprise. “There may be many Article 50-related news headlines in the coming weeks but we believe that a lot of the negativity around Brexit-related economic data weakness is already in the price,” strategists led by Hans Redeker said in a March 2 note.
The bank initiated a long sterling versus the euro trade recommendation last month and is targeting a move to 0.8000, as it sees political risks in the euro zone remaining high.
What are key things to watch during negotiations?
The key question is whether economics or populist politics dominate the negotiations, according to Bank of America economist Robert Wood. It should become apparent relatively early into the formal talks that the U.K. is on course for a harder Brexit, with all of the economic disruption that leaving Europe’s single market is likely to entail, according to JPMorgan.
Traders will focus on what the process means for the financial services industry, a key contributor to the economy, and any signs that banking or broader investment is being relocated out of the U.K. could potentially have a negative effect on the currency, said Viraj Patel, a London-based strategist at ING Groep NV.
ING says it’s worth watching the level of foreign ownership of U.K. bonds as a gauge of sentiment. Foreign ownership of U.K. bonds has slipped in the past two months and “if this becomes a six-month theme that’s telling you something,” said ING strategist Patel.
The Pinstripe and Bowler Club shares information with MF Solutions Ltd