Brexit Summit Preview: Three scenarios and GBP/USD reactions, Flextension, Euro-Fudge, or Brexident

European Council President Donald Tusk called an extraordinary leaders summit with only one topic on the agenda: Brexit. The ministers will convene on Wednesday, April 10th, from 16:00 GMT. They will meet two days before the UK is due to leave the EU, or to be precise, 54 hours before Brexit.

The summit was called after the government failed to pass the deal in its third attempt. And it followed two failed attempts by Parliament to offer alternatives. Negotiations continue in the background. UK PM Theresa May reached out to opposition leader Jeremy Corbyn, and so far, talks have not borne any fruit. Labour wants a softer Brexit that includes a customs union while the government rejects it.

Discussions with the EU and three scenarios

The same goes for talks between the UK and the EU. May meets some of her European counterparts ahead of the summit and tries to find a path forward. She has formally asked for an extension up to June 30th, trying to prevent the UK from participating in EU Parliament elections on May 23rd, with the first meeting of the new Parliament due on July 2nd. 

The EU did not like the request as they wanted to see a long extension, and more importantly, a reason for the delay.

Germany played the "good cop" by showing empathy to the UK while France played the "bad cop" with a tough stance.

All the leaders will now meet in Brussels.

1) Long extension

In the last EU Summit on March 21st, May also set June 30th as Brexit date but was answered with a different plan from the EU: May 22nd exit if the deal is approved or April 12th with an option for an extension otherwise. 

The EU may have different plans for her, and these plans are quite known. According to reports, Tusk will offer the UK a "flextension": delaying Brexit by 9-12 months with an option for an earlier exit if the UK sorts itself out.

This is, therefore, the most likely scenario, albeit far from certain. In this case, GBP/USD has room to rally quite a bit as the UK will not fall off a cliff.

Delaying Brexit by a long period will anger hard-Brexiteers, which seek to hold indicative votes on May's future. UK politics will likely become even more chaotic, but for the time being, no Brexit now could turn into no Brexit at all, and Sterling could shine.

2) A short extension to June 30th

While the EU rejects only a short extension due to the elections, they can always find a way to make it happen. For example, if the UK does not leave on June 30th, it could hold special European Parliament elections and assume their seats later on. 

Such a euro-fudge would also prevent a cliff-edge Brexit but would leave a lot of uncertainty. The advantage is that May will be able to claim victory and regain some of her lost authority. 

GBP/USD will likely move up on the better certainty in the UK despite the uncertainty about Brexit. The advance will probably fade as time passes by and the new deadline approaches. The probability of such a euro-fudge is medium.

3) Hard-Brexit

Nobody wants a hard Brexit. Ireland will be hit hardest, the UK afterward, but France, Belgium, and the Netherlands will also suffer quite a bit in the immediate term. Also, the loss of confidence in politicians, not only in the UK but also in the continent, six weeks before the elections, is indeed not the desired outcome.

However, it is the default option, and it takes just one of the 27 EU countries to veto an extension for it to fail. It may come from Italy's populist government or those in Hungary or Poland. Moreover, France may overplay its hand with the tough stance. And May would tell her counterparts that she will surely be ousted on a long Brexit delay and will be unable to push it forward. 

It is not only the default option but could happen by accident, dubbed "Brexident." In this scenario, GBP/USD is set to crash, with 1.20 a target for many analysts. The probability is low, making the reaction more violent. 

Conclusion

The EU Summit is critical, and GBP/USD is set to rock. A "flextenion" of up to 12 months is the most probable outcome and could lead to a rally. A euro-fudge with a short extension to June 30th is another potential option, and GBP/USD could cautiously advance on it. A hard-Brexit or a "Brexident" could be devastating but has a low probability.