European diplomats began hashing out what they want from the next stage of Brexit talks this week, seeking a united stance they can present to the U.K. The envoys will start to discuss the ideal length of the transition phase, its scope, and whether the bloc would impose the EU’s “four freedoms,” including free movement of people. For now, cable has been relatively stable, but as Bloomberg’s Mark Cudmore warns, the pound’s resilience to negative news may not last much longer.
This week’s round of Brexit negotiations are absolutely crucial.
With the exception of the Bank of England’s Super Thursday, sterling has traded well in the past two weeks, shrugging off a host of domestic political turmoil.
That dynamic is persisting today. The market has shown little reaction to the FT story that major financial institutions are close to a Brexit “point of no return” after which they’ll start moving “thousands” of jobs out of London, or to reports that Theresa May is on the verge of losing a second top minister in a week.
When a market shows an asymmetrically positive reaction to news, it’s normally a bullish sign. But things may change soon.
Underlying positioning has played a particularly critical role in trading sterling this year.
March saw short positions reach the most extreme level in history, according to CFTC data. That was the catalyst for the Bloomberg Pound Index to rally by 6% in less than two months.
September then saw CFTC positioning turn positive for the pound for the first time in almost two years.
The market is now roughly neutral on sterling.
You can see this in the analyst notes from banks. Brexit bears have tired of aggressively playing that theme without reward. And since the main argument of sterling bulls was that people were overly pessimistic, that angle has also evaporated.
This leaves sterling fresh to trade on a new macro theme. All it needs is a catalyst.
The fundamental backdrop for the currency is very poor: extremely negative real yields, sluggish growth and a large current-account deficit. So, barring any solid arguments to the contrary, the path to a weaker pound is well marked.
There’s valid optimism that the U.K. is finally on the verge of making progress on a Brexit deal. But what is abundantly clear is that we are now past the time when any negotiations-disappointment will be ignored by currency traders.
Some clear positive must come from this week’s Brexit talks, otherwise it could be time for long-term structural sterling bears to come out of hibernation.