Sterling traders court peril counting on 11th-hour Brexit breakthrough

Currency traders in London, preparing for an all-nighter on Tuesday as Theresa May’s EU withdrawal agreement was supposed to come before the UK parliament, were able to pack away their sleeping bags and cancel office pizza orders when the embattled prime minister delayed the vote, knowing she hadn’t a chance of pushing it through.

With the odds a no-deal Brexit tightening as May staggers next week into the final 100 days before the clock strikes midnight on March 29th, the divorce date, traders should make sure their plans over the coming months can be cancelled at short notice.

Remarkably, sterling, having slumped from 76.6p against the euro immediately before the Brexit referendum in June 2016 to as low as 92.6p in August last year, has traded during the course of 2018 in a relatively tight band of a few pence either side of 88p. That’s despite financial markets being subjected to a daily barrage of mixed Brexit headlines.

Of course, euro/sterling is not the best gauge. The single currency has had its own issues of late, including a standoff between Rome and Brussels over Italy's budget and, just this week, a warning from the European Central Bank president Mario Draghi that risks to the euro-zone economy are "moving to the downside".

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Sterling’s move against the dollar has been more pronounced, falling almost 13 per cent over the past nine months to a 20-month low of $1.2487 this week.

But that doesn’t even begin to price in the prospect of a disorderly Brexit.

Foreign reserves

Economists at Bank of America Merrill Lynch have estimated that central banks alone, holding sterling as part of their foreign reserves, could dump £100 billion of the currency should the UK crash out of the EU.

The Bank of England predicted a few weeks ago that the pound could fall 25 per cent in such a scenario. It’s the kind of move you’d typically only expect to see in emerging markets, which would push sterling through parity with the dollar for the first time.

While many commentators compare such an event to “Black Wednesday” in 1992, when sterling plummeted as Britain was forced to pull out of the European Exchange Rate Mechanism, the difference is that the pound started off in the early 1990s from a position where it was widely acknowledged to be chronically overvalued.

Buttressing sterling at the moment – even as EU leaders rejected on Thursday evening May’s plea to put a time limit on the Northern Ireland backstop – is lingering chatter in Westminster and the City of London that a likely violent market reaction as the UK moves close to the cliff edge will force MPs to see the light and wave through the withdrawal agreement.

‘Tarp’ vista

This is known as the "Tarp scenario". It's a reference to former US president George W Bush's $700 billion bank bailout plan, the "troubled asset relief programme", that was initially rejected by Congress weeks after the collapse of Lehman Brothers in September 2008. The financial markets chaos that ensured on Wall Street prompted lawmakers to back the plan on a second attempt.

There are a few problems with this theory, however, including the fact that every time sterling sells off against the dollar, it tends to boost London’s FTSE 100, given how the index is dominated by dollar-earning exporters.

But the biggest issue, however, is that as long as sterling traders cling on to the hope that the Tarp scenario will play out, the less likely it is that it will happen – until, perhaps, it is too late.

Has Elliott gatecrashed wrong drinks party?

Few things strike terror in the hearts of corporate boardrooms as much as a sign that billionaire hedge fund manager Paul Singer’s Elliott Management is building up a stake in a company. Investors, however, tend to take a different view.

Shares in French drinks giant Pernod Ricard, which acquired the Jameson Whiskey brand 30 years ago when it bought Irish Distillers, soared almost 6 per cent on Wednesday when Elliott disclosed that it owns more than 2.5 per cent of the company – days after it emerged that the fund manager had accumulated an interest in German drugmaker Bayer and was pressing for a break-up of the group.

At Pernod, Elliott is looking for "operational and governance improvements" and an increase in its profit margin to that of rival Diageo, owner of Guinness.

It's all got Deutsche Bank analyst Andrea Pistacchi scratching his head, given that Pernod's stock is close to all-time highs, and trading on "relatively high" earnings multiples, having outperformed Diageo over the past 12 months.

“Moreover, management has brought some change in the past few years, simplifying the organisation, reducing costs (to some extent) and the group’s operational performance is as strong as it has been in a long time,” he said.

Has Elliott gatecrashed the wrong drinks party?