GBP - Trade or Fade the Brexit Vote?

Nothing is more important this week that the Brexit votes on Tuesday, Wednesday and possibly also Thursday. There's no exact time for the vote but it will be after the debates, which usually end evening time in the UK. That puts a vote somewhere after 18/19 GMT or 2pm/3pm NY time. It could be even later but it shouldn't be earlier than 18 GMT. This week's vote will determine 3 things -

1. Will the UK accept the EU's withdrawal agreement
2. Will the UK rule out leaving with no deal
3. Will Article 50 be extended?

For the vote, there are only 2 outcomes - members of Parliament will choose to back the withdrawal agreement or reject it.  If they accept the deal, Theresa May's strategy will be vindicated, the UK will leave the EU on March 29th and GBP will soar for no reason other than a certain outcome. While we could see a quick 1-2% rally, it may be difficult for the gains to be sustained as investors turn their focus to the consequences of leaving the European Union with no permanent trade agreements ad the challenges the UK will have in negotiating from a isolated position.

What's most likely going to happen however is MPs will strike down the deal. There's already reports that May's Cabinet rejected the EU's latest backstop proposals. May has been unable to convince the EU the change the Irish backstop terms and unable to get enough MPs to accept the current deal. If the withdrawal agreement is rejected, May will hold a vote Wednesday on whether the UK should leave the EU with no deal.She's been insistent that no deal is better than a bad deal and if MPs feel the same way, then there's serious trouble ahead. This would be the worse case scenario for the GBP. Bank of England Governor Carney warned us before that a no deal Brexit could cause a 25% collapse in GBP. While we don't expect that to happen in a blink of an eye, the sheer reality of a no deal Brexit will be enough to send GBP/USD down 2 to 4 percent in a matter of minutes.

Leaving with no deal is irresponsible. Most MPs feel this way, which is support for a no-deal Brexit should be minimal. GBP, which would have fallen on Tuesday after a rejection of the withdrawal bill could rally briefly in this scenario but then the focus shifts to the next vote on Thursday on whether Article 50 should be extended.

Now there's one more possible outcome - which is that the withdrawal agreement is rejected by a thin margin. In this case, May could go for a Hail Mary and try for another vote after the March 22nd EU Summit. This could lead to the technical no deal exit that the EU previously mentioned but regardless of whether its technical or real, sterling traders won't interpret a further delay in a final decision as positive for the currency.

Meanwhile the US dollar completely shrugged off better than retail sales numbers. Consumer spending rose 0.2% in the month of January, which was only slighter more than the 0% forecast but excluding autos and gas, spending rose 1.2% which was double expectations. Consumer demand is off to a good start in the first quarter and could strengthen as wages rise. However, the economy is still reeling from end of year weakness and investors are not convinced that the outlook is bright. CPI is scheduled for release tomorrow and the uptick in oil prices should drive inflation higher. Unfortunately the increase won't be enough - inflation is still very low with CPI running well beneath 2% yoy.

We continue to look for 1.10 in euro. Today's economic reports reinforce the central bank's concerns about weaker growth. German industrial production fell -0.8% in January as exports stagnate, causing the trade surplus to rise less than expected. The current account balance also declined as trouble in the auto sector affect beginning of the year results. The ECB made it very clear last week that TLTRO 3 is a form of accommodation and they stand ready to do more if Brexit is disruptive or global growth slows further. With the gap between US and German yields widening, EUR/USD is headed lower.