UK: What to look out for in the May speech and how short is GBP positioning? – Deutsche Bank
Oliver Harvey, Macro strategist at Deutsche Bank, notes that at 11.45 Tuesday, Prime Minister May will deliver the most anticipated speech on Brexit since the UK’s referendum to leave the EU last June.
Key Quotes
“Weekend press suggested that May would use it as an opportunity to outline a hard initial stance. What issues are at stake and what should the market look for?”
“Will the UK seek customs union access? The most material news on Sunday, if confirmed, was that the Prime Minister was prepared to give up access to the customs union. As noted by the House of Lords, this is an early decision the UK will make in the Brexit process as third country trade deals are impossible without clarity on this issue. A customs union exit would be consistent with WTO rules (although some exceptions exist), and therefore ‘hard Brexit.’ It would be the most economically disruptive outcome in terms of trade with the EU, but an early decision would also open the door to negotiate trade deals with the rest of the world in parallel to EU talks.”
“What, if any, industrial sectors will aim to receive special treatment? The UK government recognizes that customs union access is important for certain UK export sectors. The UK may seek specific access to the customs union for some sectors, watering down the terms of trade shock of hard Brexit, or an interim deal.”
“What kind of interim agreement will the UK seek? Recent rhetoric suggests that the government recognizes the dangers of a ‘cliff edge’ if no deal is reached by the end of the two years under Article 50. On this front, will May seek assurances on a transitional period at a very early stage of the negotiations (more bullish)? Is a transitional deal seen as contingent on a wider EU deal (less bullish – currently Brexit Secretary David Davis’s position) or used to play for time? Will a transitional deal be sector specific?”
“What treatment for the City of London? Similarly, recent reports suggest the EU recognizes the potential dangers for EU financial stability of a sudden loss of UK passporting or migration of financial infrastructure to the continent. Does the UK seek agreement on continued passporting for UK banks (most bullish)?, or a third party equivalence regime (recently argued for by Policy Exchange and more disruptive for the UK financial sector in the short run)?”
“What are the UK’s red lines? Perhaps most importantly, the quid pro quo for UK economic demands will be the ability to compromise on other issues in the negotiation. The most important are immigration, the scope of EU law and contributions to the EU budget. On immigration, it will be important to see if May defines further the phrase ‘full control of the borders.’ If taken in a narrow sense this could mean simply repatriating power over immigration consistent with articles in the EEA Treaty. A more specific definition (e.g. prescriptive sector based quotas or a points-based system) would make the UK stance less flexible and imply less prospect of compromise. Similarly on EU law, is the question one of regaining primacy (closer to EEA)? or regulatory independence (less scope for compromise)?. EU budget contributions are the least problematic compromise given that government ministers have indicated contributions could continue to be made in exchange for economic concessions.”
“A UK-wide Brexit? The Scottish Nationalist Party (SNP) have made continued access to the Single Market a precondition of the Brexit negotiations and called for a second Scottish independence referendum if this is not met. A lack of concessions from the UK government for Scotland could raise longer term risks of a UK break-up, but also be problematic if the Supreme Court were to rule that the devolved authorities must be consulted before the triggering of Article 50. We anticipate a decision on the latter in the next two weeks. Immigration red lines, the scope of EU law, customs union access and the timing of striking an interim deal are most important. It is possible much detail may not be forthcoming. In general, the more prescriptive demands on migration and EU law are the less prospect of compromise. A lukewarm attitude to the customs union should also be more bearish for sterling.”
“How short is sterling positioning? Finally, given the focus on tomorrow’s speech, it is worth a recap of sterling positioning. Headline IMM positioning suggests sizeable sterling shorts, but benchmarking sterling positioning to the referendum date (see charts below) suggests both the overall market and the leveraged fund shorts are not at extreme levels yet. Similarly, our CORAX report suggests profit taking on sterling shorts in recent weeks from leveraged funds and asset managers.”