Brexit Deal In Sight: Which Currencies Are Set To Rally?

Kathy Lien, Managing Director Of FX Strategy For BK Asset Management

Daily FX Market Roundup October 16, 2019

With 16 days to go before the UK is scheduled to leave the European Union, a Brexit deal is finally in sight but it's still important for investors to tread cautiously because of the inevitable resistance from the DUP and reports from “senior EU officials” that it's “way too premature” to assume that a Brexit deal is imminent. Nonetheless, sterling and many other major currencies traded sharply higher Tuesday on reports that EU and UK Brexit negotiators are close to a deal after Boris Johnson agreed to have a customs border down the Irish Sea. As the negotiations proceed and we watch for comments from EU and DUP officials, the rollercoaster ride will continue for sterling.

What makes today’s price action valuable are the currencies that reacted to the news and the ones that didn’t as they will provide a guide to how we should trade when the deal is made official. An agreement that assures a smooth exit is good for everyone because it eliminates one of the biggest uncertainties and darkest clouds hovering over the markets for the past few years. If the UK were to leave the European Union with no agreement, the biggest disruptions will be to the EU and UK. In that case, the greatest weakness will be in sterling and the euro. By the same token, sterling and the euro will rally the most when an agreement is announced. We saw a glimpse of that today when EUR/USD surged 50 pips in less than an hour on Brexit news. Of course, sterling’s reaction was even greater with GBP jumping more than 100 pips in a matter of minutes. USD/JPY also rallied on the news and its gains drove all of the yen crosses higher. Although AUD/USD and NZD/USD perked up as well, their moves were modest and unsustainable while USD/CHF barely budged. So when a deal is announced, our favorite currencies to buy will be GBP/JPY, GBP/CHF, GBP/AUD, EUR/JPY, EUR/AUD, EUR/CHF and EUR/NZD.

As we saw today, data mattered little to sterling in such a politically charged week. UK labor market numbers were worse than expected with jobless claims rising and average weekly earnings slowing. CPI numbers are scheduled for release tomorrow and while monthly price growth is expected to ease, on a year-over-year basis prices should have accelerated. Euro, which started the NY session weak ended the day unchanged despite a lower-than-expected ZEW survey. Investors grew more pessimistic about current and future conditions in Germany, a situation that should worsen as incoming data shows the economy falling into recession.

USD/JPY and USD/CAD will be in focus tomorrow with US retail sales and Canadian CPI scheduled for release. Although USD/JPY surged toward 109 today, weaker wage growth is a precursor to weakening demand. Economists are looking for retail sales growth to slow to 0.3% from 0.4% in September but a worse outcome will renew the pair’s decline and expectations for easing later this month. The Beige Book will come out in the afternoon and we expect Fed districts to report weakness. Canada’s inflation numbers on the other hand should surprise to the upside with IVEY PMI reporting a significant jump in prices. Strong underlying fundamentals helped Canada defy the slide in oil prices today but for the rally to continue, CPI needs to be strong. New Zealand inflation data is also scheduled for release and like the UK and Canada, higher prices are expected.