Cutting long GBP/USD as PM May faces a potential leadership contest - Nomura

Because UK domestic risks have heated up with a potential leadership contest in the Conservative party rising in market pricing, analysts at Nomura deem it worthwhile taking profit in their GBP long position.

Key Quotes:

"Short-term risks are too high, but long-term upside remains."

"If a leadership contest is avoided and a deal with the EU is agreed we will review being flat GBP as it is our base case for GBP to trade materially higher once a deal is agreed. Just at this time the risks are too high in the short term to hold a long position. But despite our view that a leadership confidence vote on Theresa May is no more than hyped up tail risk, we admit the Conservative party has never looked closer to triggering such action as it does today. The main difference being that both sides of the Conservative party look to be disgruntled with the direction of Brexit policy, the centrists and the Brexiteers."

"We may be over reacting to the news flow, but at this time we would rather be flat than holding GBP longs and would advise holding short 1-2 week GBP hedges for downside in the event the tail risk of a leadership contest occurs. "

"The whole process from step one to step four takes roughly two to three months, but can be fast tracked by skipping a membership vote (Theresa May replaced David Cameron within three weeks):

Step 1: 48 MPs sign a letter expressing no confidence in the party leader and a no confidence vote is called by the 1922 committee (which oversees leadership elections and represents the backbenches). 

Step 2: If Theresa May fails to keep her MPs’ confidence and loses the vote, a leadership contest is called and MPs submit their names for the ballot with at least two MPs backing them. Theresa May would not be able to stand for reelection. The last leader to lose a confidence vote was Ian Duncan Smith in 2003. 

Step 3: If more than two candidates apply there are two votes per week (Tuesdays and Thursdays) until the final two contestants are reached.  

Step 4: Once the final two are chosen, the wider party membership postal vote takes place "as soon as it is practicable" to conduct. Typically, that means two months, but it is flexible."