Pound-Canadian Dollar Rate Volatile as Brexit Cliff Edge, Ratification Risk Looms

- GBP/CAD offers poor risk-reward to all as volatility continues.
- Cliff edge and ratification risk loom as Brexit clock ticks down. 
- CAD outperforms other majors as USD benefits from illiquidity.

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• GBP/CAD spot rate at time of writing: 1.7221
• Bank transfer rate (indicative guide): 1.6622-1.6743
• FX specialist providers (indicative guide): 1.6967-1.7104
• More information on FX specialist rates here 

The Pound-Canadian Dollar remained volatile in illiquid holiday trade on Tuesday as time slipped away from Brexit negotiators, bringing a cliff edge and ratification risks into focus for an already badly bruised Sterling. 

Sterling volatility continued Tuesday with GBP/CAD trading around the middle of its recent range and in the process offering a mere one-for-one balance of risk and reward to prospective buyers and sellers as the Brexit clock ticked away. 

"Trend signals are flat— neutral—across intraday, daily and weekly DMI oscillators, suggesting wide and choppy range trading will extend while the GBP’s current position near the mid-point of recent range extremes leaves the market poorly positioned from a risk/reward perspective—there is little incentive to take a view on short-term directional risks, in other words," says Juan Manuel Herrera, a strategist at Scotiabank. "We look for firm support near 1.6750/00. Resistance is 1.75/1.76." 

The two sides have barely more than a week until the end of the Brexit transition period ends on December 31 and the UK defaults to doing business with the bloc according to World Trade Organization (WTO) rules and with Most Favoured Nation tariff rates in effect. However and in reality, there's even less than this given that it takes days if-not longer for a new bill to become law.

"As we have noted before, the pathway to a deal is still a political “choreography" and the timing is important; it might take a little more brinksmanship to make compromise palatable, perhaps similar to how progress has reportedly been made on the “level playing field” issue," says Zach Pandl, global co-head of foreign exchange strategy at Goldman Sachs. "We maintain our base case for a “thin” FTA by year-end and continue to think investors should stay long Sterling."

Above: Pound-to-Canadian Dollar rate shown at hourly intervals.

The Goldman team says "risk-reward looks less attractive at current levels than a week ago," but still favours holding onto the Pound rather than selling it. The bank prefers to trade EUR/GBP but has a three-month forecast of 1.7750 for GBP/CAD, which is around 3% above Tuesday's 1.7225 level. 

However, even if a deal is eventually agreed the Pound may be susceptible to fresh losses in the short-term and a return toward the bottom of a recent range spanning the gap between 1.69 and 1.75 the longer negotiators take.  

"An EU diplomat said an hour ago that there’s been no breakthrough in Brexit talks and no agreement on fisheries," says Eric Bregar, head of FX strategy at Exchange Bank of Canada. "GBPUSD loses the 1.3390s and makes a bee line for its next support level in the 1.3320s."

Sterling's problem in the short-term is that all of Europe's parliaments will need to ratify any agreement before it can come into force, which means there's a chance that even if negotiators are able to overcome the last remaining hurdles in the trade talks, the Pound may still suffer short-term losses if it begins to look likely that ratification will not be possible until the New Year. 

Brexit-supporting lawmakers in the UK have already indicated that they'd be reluctant to give their seal of approval to anything agreed by Prime Minister Boris Johnson without first having had time to "go through it with a fine-tooth comb." It's expected that any agreement would run to thousands of pages text and legal jargon, likely making it impossible to scrutinise in a simple matter of days, and under these circumstances it's possible that some of the government's MPs could abstain in any parliamentary vote.

Above: Pound-to-Canadian Dollar rate shown at daily intervals alongside USD/CAD (orange line). 

"The overall pattern of trade suggests a mild risk-off tone in FX," says Shaun Osborne, chief FX strategist at Scotiabank. "The CAD is modestly weaker against the USD but is a relative out-performer in the G10 space, giving the CAD a bit of a lift on the crosses on the day. Mixed stocks and softer energy prices cloud the CAD mood somewhat." 

Any abstentions by Conservative Party MPs could potentially see the Prime Minister failing to secure the necessary support for his agreement on the first asking of parliament, leading to a situation where an emergency extension of the Brexit transition period becomes necessary or else Sterling faces a period of legal limbo outside of the transition period and in something like 'no deal' Brexit land. It's not clear what would become of the Pound in those circumstances. 

Meanwhile, the Canadian Dollar continued to outperform many other commodity currencies on Tuesday even as the USD/CAD rate set itself on course for its largest one-day gain since early November. The nascent USD/CAD rally was not enough to spare GBP/CAD from losses on Tuesday, which is a clear sign of investors' aversion to Sterling given that GBP/CAD often rises with USD/CAD in bouts of risk aversion like those seen this week.

"FX investors can probably foresee a situation in which no formal deal is reached by December 31 and a temporary arrangement is agreed that maintains 100% tariff-free trade. But there are two key risks to this scenario: the first is the government's preoccupation with managing COVID-19 and its economic impact (the appetite for an extension on the UK side appears very low). The second risk is that a temporary arrangement may require one or two big concessions from either side to occur first," says Stephen Gallo, European head of FX strategy at BMO Capital Markets. "Given what the positioning data of leveraged funds show, there is probably a lot more 'pain' on the downside in USDCAD than on the topside (this is perhaps demonstrated by the fact the CAD is closer to the middle of the G10 pack in terms of its daily return). That being said, low liquidity needs to be accounted for by investors as holiday-thinned trading continues this week." 

Above: Pound-to-Canadian Dollar rate shown at weekly intervals alongside USD/CAD (orange line).