Another deadline set and another deadline missed. In what was a tumultuous period for markets last week, negotiators from the EU and the UK saw another key date come and go, and a “no-deal” avoided (for now?).

Following a brief phone call on Sunday between Boris Johnson and Ursula von der Leyen, it was agreed that both sides would ‘go the extra mile’ to get an acceptable UK-EU trade agreement in place. Stakeholders from both parties have since been mandated to continue talks, this time without a set ‘deadline’ (at least, not one that expires before December 31st), although Michel Barnier tweeted that ‘the next few days are important’.

On Monday, markets reacted positively to the news, seeing the prolonging of discussions as a sign of a possible deal. Sterling rose 1.4% against the dollar on the back of this news, putting it on course for its biggest daily rise since October. The pound also reclaimed some ground against the euro, up close to 1% yesterday morning.

However, we have seen sentiment turn ‘risk off’ overnight, with COVID-related headlines dictating market price dynamics. As it stands, GBPUSD is trading sideways between 1.3250-1.3380 and GBPEUR between 1.0970-1.1050.

Yesterday, betting platform Smarkets reflected renewed market optimism, showing 72% probability of a deal being agreed, up from 64% in our last publication. It is also worth noting that the odds of a deal dipped below 50% late last week. Odds currently sit back at 65%, suggesting that the longer negotiations continue, the less faith the betting market has in a deal being reached. Our gut feeling is that these odds are still over-priced, particularly with the time (or lack of!) constraints.

So, what next?
1. Deal – Validus Estimated Probability = 60%

GBPUSD range – 1.35-1.37

GBPEUR range – 1.1250-1.14

  • General sentiment has been lifted following Michel Barnier’s comments yesterday, stating that he sees a “narrow path to a deal”. Betting markets now have a deal as the most likely scenario, up from a 50/50 split late last week, a projection which is commensurate with most major banking forecasts.
2. Extension to Transition Period – Validus Estimated Probability = 10%

GBPUSD range – 1.33-1.35

GBPEUR range – 1.1080-1.1250

  • An extension currently sits as the least likely scenario, although it cannot be ruled out.  Betting markets currently price an extension at around 25%, although this appears high considering the political constraints facing Boris Johnson. The UK has been vehemently opposed to any extension throughout negotiations. However, one would be remiss to ignore this as a possibility, given concessions made on both sides to get to this point and the fact that time is rapidly running out.
  • An extension could also come in the event of an 11th hour deal (albeit this could technically fall into the deal category) to allow for ratification within respective EU parliaments.
  • Consensus is that the EU and its member states require at least a couple of weeks to ratify a deal. With the end of the Brexit transition period now 16 days away, this leaves precious little time for national EU parliaments and the EU council to approve a deal, should one be agreed.
3. No deal – Validus Estimated Probability = 30%

GBPUSD range – 1.25-1.30

GBPEUR range – 1.04-1.08

  • Once again, this seems less likely than a deal, at least according to the latest betting odds. However, one cannot ignore this eventuality and the knock-on effect on global financial markets. Boris Johnson has repeatedly claimed that the UK would thrive on an ‘Australian-style’ trading arrangement with the EU. Although, practically speaking, global markets are much more bearish. Data varies, but the Bank of England has forecast a 2% reduction in UK GDP by 2022 if no agreement was to be reached.
  • By now, we are all well aware of the key ‘sticking points’ that have dogged negotiations to this point. Fishing, which contributes just 0.1% to UK GDP, has provided further contention over the weekend, with the threat of UK naval intervention. One anonymous EU diplomat has stated that London must accept “inherent trade-offs” for a fair deal.
Option Volatility / Risk reversals

In terms of the market view, the jury is still out as to whether a deal can be reached, heightening the volatility surrounding sterling. GBPUSD and GBPEUR one-month option volatility peaked at close to 14.5% and 13.5% respectively on Friday evening – levels currently sit at 12.5% and 11.25%. In other words, markets are currently placing a 20% probability on GBPUSD trading both as high as 1.3750 and as low as 1.3050 by year-end. Similarly, the probabilities of GBPEUR trading at 1.1350 and 1.0800 are 16.4% and 16.8% respectively. Finally, risk reversals have become more negative still, highlighting the downside risk posed to the pound.

With little in the way of a definitive timeline for this week’s negotiations, we all remain in ‘wait and see’ mode. Can anyone else feel a sense of déjà vu?