The Brexit saga didn’t quite end with the UK leaving the European Union at 11:00pm (GMT) on 31 January 2020. What started was a period of transition, scheduled to end on December 31. During this time, the UK is still bound to the rules of the European Union and remains a part of the EU single market.

What this essentially means is that, during this period, the UK will continue to enjoy:

  • Freedom of travelling to and from the EU
  • Freedom to live and work in any of the EU countries
  • Trade with the EU without any additional checks or charges

The only thing that changed was the UK gaining political autonomy, leaving the European Parliament and European Commission.

So Close, Yet So Far

So, why does the UK need 11 months to transition to a state that its citizens voted in favour of way back in 2016? It’s the all-important trade deal, hanging like a guillotine to finally severe the UK from the EU.

The UK wants a free trade deal with the EU, which means trading without any tariffs, quotas or other barriers being levied. This is critical for Britain, as almost 50% of its exports are to the EU. However, after months of intense negotiations, we’re down to the last couple of weeks before the transition period ends. And the two sides continue to have major differences in key issues, including rights to fisheries, competition rules and the governance of any trade treaty.

What’s Infecting Market Sentiment?

The transition period will end as scheduled, on 31 December 2020. But before we consider the scenarios with Brexit, here’s something to think about.

The challenges that the UK will face, and the prospects of its economy next year have changed dramatically since the Brexit was finalised. The culprit is the coronavirus pandemic. As of December 18, there were almost 2 million confirmed cases and over 66,000 deaths in the country. Market sentiment around the UK’s prospects is probably at an all-time low, despite the country being the first in the world to approve a covid-19 vaccine that had been through rigorous last stage trials. There are widespread concerns, however, around the fate of the UK economy with analysts projecting restrictions across much of the country to remain in place at least till February.

What’s the Deal with the End of the Transition Period?

The date for finalising the UK-EU trade deal has been extended. But time is running out. While European Commission president Ursula von der Leyen said on December 16 that the negotiators had made progress and the two sides were inching closer to an agreement, UK Prime Minister Boris Johnson warned of a no-deal exit. How markets respond to the end of the transition period will depend largely on whether the UK exits with or without a trade deal.

How the Markets May Respond to a No-Deal Brexit

The covid-19 scenario could not have been foreseen, by economists or the markets. If the UK exits the transitional period without a free trade deal, it could mean serious downside risk for the UK stock market and currency.

Investors could consider short selling the FTSE 100. While the Dutch and Swiss indices may find favour among traders, there could be some selling pressure on the Euro 50, French 40, and German 30 indices. Traders may also use call options, which are conditional derivative contracts allowing holders to go long on indices at a chosen price. With this instrument, traders can simply allow the options to expire in case prices move in an unfavourable direction.

This is because both Brexit and the covid-19 outbreak have serious implications for the short- and medium-term prospects of the UK economy. In a bid to trigger economic growth, the Bank of England could cut its benchmark interest rate to 0% and increase quantitative easing measures next year. This will exert further pressure on the pound.

Mizuho analysts said in a recent note, however, that a no-deal exit is unlikely to have a ripple effect in the global financial markets.

How the Markets May Respond to a UK-EU Deal Being Inked

The pound and euro rallied following the extension of the deadline for negotiations. Markets seem to be already pricing in the signing of a deal between the two regions. On December 17, the pound hit a two-and-a-half-year high versus the US dollar. In case the UK-EU deal is inked, there could be an upturn in the GBP/USD and EUR/USD, especially with the greenback remaining under pressure on news of the US government closing in on a fresh stimulus package of $900 billion.

Analysts at Barclays project the British pound to breach the $1.35 barrier and continue rising in case a deal is signed.

Other Considerations

While the UK-EU trade deal negotiations are ongoing, the UK cannot hold formal trade talks with other countries. Once the negotiations are done, whether with or without a deal, there may be good news related to UK’s trade talks with the US and Australia. This could support the markets.

Meanwhile, the end of a coronavirus infected 2020 and the beginning of a new year with vaccination distribution gaining momentum could keep markets in a festive mood. Markets have already turned bullish as the year draws to an end. Stock markets are rising, Bitcoin recently breached another record high after shattering the $20,000 mark and oil prices have recovered to a nine-month high. European stocks and the euro have also rallied with improving investor risk appetite. The only asset to really suffer has been the US dollar, a trend that could continue well into the new year, despite the currency trading at around two and a half year lows against major rivals.

Which currencies and indices will you trade during the Brexit transition period? Tweet us at @Derivdotcom and share your views.

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The contents of this article do not constitute trading advice and should be treated as general information only.

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