Pound May See Only a Limited Rally Even If Brexit Deal Is Passed

(Bloomberg) — Forecasts for the to rally above $1.35 may be too optimistic even if Boris Johnson gets approval in Parliament for his Brexit deal.

Sterling opened lower after U.K. politicians failed to deliver the decisive Brexit vote that had been promised at the weekend. Still, analysis of Saturday’s debate and the comments that lawmakers made during it, shows the U.K. prime minister still has a chance of getting his Brexit deal done. This hasn’t boosted the U.K. currency on Monday, in a sign that current pricing may already be reflecting optimism that the Brexit accord will eventually pass.

Options gauges also suggest that a level close to $1.30 in pound-dollar is incorporating a high probability that Johnson will get his way in the House of Commons. Overnight volatility rose to its strongest level since the U.K. elections in June 2017 on bets that Commons Speaker John Bercow may allow the vote to take place Monday. This at at time when traders acknowledge high risks that the pound may weaken in the short term, as risk reversals show.

Certainly, a vote in favor of the Brexit deal could see the pound rallying. This, however, may only amount to a knee-jerk reaction and investors may be looking to fade the move.

Russell Silberston, a portfolio manager at Investec Asset Management Ltd., estimates the Brexit deal is already 60%-to-70% priced in, and that the currency could gain to at least $1.33 on a deal passing through Parliament.

“On the negative side, however, is the relatively short transition – Dec 2020,” he said. “It seems highly unlikely we can get a free trade deal with the EU by then, so I think this tempers the medium term view.”

Corporate names have already taken profit on long exposure through options. Real money accounts still prefer to sell rallies, while hedge funds’ flows run two-ways, according to three traders in Europe who asked not to be identified because they are not authorized to speak publicly.

Technically, the first key resistance comes around $1.3150 and may be where a knee-jerk rally will stall. The 200-weekly moving average stands at $1.3149, while the midpoint of sterling’s losses since April 2018 comes at $1.3168. Its May 6 high is at $1.3185.

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