British Pound: A Wild West of the Currency Market as “Dreadful Liquidity” Presides Over Brexit

- GBP exchange rates could see Wild West price swings ahead.
- As "dreadful liquidity" in GBP rates to meet Q4 Brexit deadlines.
- Means dreadful driving conditions for investors & GBP volatility.

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• GBP/USD spot rate at time of writing: 1.2742
• Bank transfer rate (indicative guide): 1.2415-1.2505
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The Pound was the third best performing major currency for the week on Friday and despite an inhospitable environment for risk assets, but price action could get wilder in the weeks ahead if currently “dreadful liquidity”conditions and the final quarter’s Brexit deadlines collide. 

Sterling was trailing only the safe-haven Dollar and Japanese Yen for the week but with few prospective catalysts to explain the continued about turn in fortune, other than a series of statements suggesting a Brexit trade agreement or covert extension of transition period still cannot be ruled out.

“We continue to stand aside from our bearish GBP view for now as the positioning overhang from September still persists,” says the London FX desk at J.P. Morgan in a Friday commentary. “The Brexit news-flow risk is skewed to the positive side (for now and from a very low base).” 

Above: Pound Sterling performance against major currencies this week. Source: Pound Sterling Live. 

Bets against the Pound have risen in September, according to Chicago Futures Trading Commission data, as losses mounted with the decibel level in the UK-EU trade talks after the Internal Market Bill drew outrage from Brussels and a number of the UK’s not-very-popular and now-former Prime Ministers.  

But confrontation has either been placed on hold, as was indicated by The Express, or moved behind closed doors. Meanwhile, an influential trade adviser to the ruling Conservative Party spoke openly before the Brexit Committee of a possible “implementation period” to follow on from December 31. 

Remarks from Shankar Singham indicated that in private and under certain circumstances the government may not be quite as firmly opposed to an extension of the Brexit transition period as was often claimed. That too was an “implementation period” until it became unavoidable that nothing would be implemented during the time concerned.

Above: Pound Sterling performance against major currencies in 20 trading days to Friday. Source: Pound Sterling Live. 

"A bad week for global equities and a bad week for European Covid19 infection rates, has bene a good week for the dollar," says Kit Juckes, chief FX strategist at Societe Generale. "GBP fell less than some because it started from a weak level after recent events, and the market is rethinking both the danger of a no-deal Brexit (hope of a last-minute deal somehow persists) and of negative rates (BOE Governor Bailey has calmed nerves slightly)." 

This week’s recovery didn’t reach the Pound-to-Dollar rate, which has fallen back to the 1.27 level last seen in late July amid a recovery of the Dollar, although that Sterling didn’t fall as far against the greenback could indicate profit-taking on earlier bearish wagers.

Some may be rethinking once-mounting expectations of a ‘no deal’ Brexit. 

Above: Pound Sterling performance against major currencies in 2020. Source: Pound Sterling Live. 

J.P. Morgan traders saw hedge funds and ‘real money’ investors like pension and insurance funds buying back the Pound at times this week, but also noted that many investors have become less willing to commit to Sterling.

“It continues to trade very erratically, with dreadful liquidity within recent ranges,” they say. "Keeping our tactical hat on for now."

J.P. Morgan's traders in London are handling flows transiting the balance sheet of the world’s seventh largest bank by assets (fifth if not for certain U.S. accounting rules), and doing so from the world's currency trading capital where Pound Sterling is no longer getting the look-in that it once did. 

Above: Pound Sterling performance against major currencies in 365 days to Friday. Source: Pound Sterling Live. 

This is not so much new news as it is increasingly important for those who’re at risk from swings in Sterling, because even more meaningful those moves could soon become as a result of it - and in both directions too.

That’s part of what poor liquidity does and although this is commonplace in emerging markets, it’s not normal for reserve currencies like the Pound. 

“Recent price action supports our narrative that GBP is effectively trading like an EM currency,” says Kamal Sharma, a strategist at BofA Global Research.

Above: Pound Sterling performance against major currencies in five years to Friday. Source: Pound Sterling Live. 

“Sterling remains the second worst performing G10 currency this year (after NOK), in line with our long-standing bearish view. Whilst there has been a much needed recalibration of Brexit risks, we still believe that the market thinks that UK-EU will eventually agree on a deal. That remains our base case scenario as well, but we are less optimistic than current market pricing and consequently maintain a bearish view on GBP into year-end, primarily on GBP crosses: EUR/GBP; GBP/JPY and GBP/CHF,” Sharma says in the latest update.

Sharma and the BofA team have observed many times that since the referendum there’s been a deterioration in “liquidity conditions” that are closely connected to the overall level of trading activity in Sterling, as well as market participants’ perceptions of the risks that come with dealing in the currency.

Only the Prime Minister and counterparts know how the Brexit cards will fall but with deteriorating liquidity offering only "dreadful" investor driving conditions, the road ahead is likely to be bumpy and may leave Sterling exchange rates looking like the currency market's Wild West for at least some of that time.

Above: Pound-to-Dollar exchange rate shown at monthly intervals alongside Pound-to-Euro rate (green line, left axis).