GBP/USD to nosedive 5-7% to 1.19-1.22 on a no-deal outcome – TDS

Brexit remains in focus and GBP has weakened on suggestions the latest round in negotiations has hit a snag. Economists at TD Securities had anticipated a souring of the week’s earlier tone and think the cable should continue to lag its peers near-term. Further out, however, they think sterling has a lot of bad news in the price and wonder if downside risks for cable of a no-deal outcome are starting to diminish.

Key quotes

“Headlines today from ‘EU Sources’ stated that the EU and UK failed to close their differences on state aid. Together with some lingering questions over Northern Ireland, this is the issue where the two sides still seem the furthest apart. EU President von der Leyen announced that the EU will begin legal action against the UK for its violation of the Withdrawal Agreement. The EU has issued the UK a letter of formal notice, and has given the UK one month to respond. This move is largely symbolic. In any case, it kicks the can down the road by a few more weeks, while any actual legal proceedings would take months (at least) to unfold.”

“Looking forward, we are wondering whether a good portion of the challenges Brexit poses for sterling may now be priced. Again, we think the ‘shock value’ of failing to reach a deal by the end of the year will see GBP weaken — and probably sharply at that. We are no longer as confident, however, in stating it will stay that way. We think Brexit issues will remain a tactical volatility driver for sterling, especially during times when it is topical (this week, for example). At the same time, however, we think Brexit’s days as being the primary strategic factor driving GBP’s direction may be coming to an end. If nothing else, the clock is running down.”

“We think the shock value of a sudden and largely-unexpected no-deal outcome could be worth as much as a 5-7% drop in cable in the immediate aftermath of the event. From current levels, for example, that would imply a spike down to the 1.19-1.22 zone. Interestingly, this is the neighborhood where we have seen cable bounce repeatedly since the referendum.”

“Looking at 2021-Q4 as an anchor, we are fairly bullish on sterling on a longer-term basis with a forecast of 1.38. In a harder Brexit scenario, we think sterling would still recover, but more slowly. We would want to see how the dust settled, but we would not be too surprised if sterling managed to end next year around 1.30-1.32.”