Dünya Executive - - REPORT - Fabr ce Montagne, econom st, Barclays

Markets may be getting overly optimistic on the prospects of a deal or an extension of Article 50 (A50) negotiatio­n period. While passage of a Withdrawal Agreement (WA) remains our base case – albeit increasing­ly likely to require a short-term extension of A50 – time is running out, and the plot thickens with complicati­ons. Propelled by optimism over the ‘Cooper amendment’ and signs of positions softening among key stakeholde­rs, FX markets now price an extraordin­arily low likelihood of a ‘no deal’ Brexit or another extreme outcome. Sterling has rallied effectivel­y to levels we expect to prevail upon passage of a WA and GBP option-implied volatility has dropped to levels that prevailed before widespread opposition to the negotiated Brexit deal became apparent in early December 2018. Sterling rates pricing is more opaque but the erosion of pricing of the tail risk of ‘no deal’ has moved forward the priced timing of the first rate hike from December 2020 to mid-Q2/3 2020. Although we hold to our base case that a WA likely will be agreed, perhaps with a short-term A50 extension, we believe markets are too optimistic among rising probabilit­ies of more extreme outcomes. Despite building momentum around the ‘Cooper’ amendment, we believe the risks it fails are higher than markets appear to assume. Among the plethora of amendments, markets seem to have identified as most relevant an amendment proposed by backbench Labour MP Yvette Cooper, which would allow parliament to usurp control of the Brexit process by requiring the Prime Minister to request an extension of the A50 negotiatio­n period in the event Parliament cannot agree on a WA by 26 February. Labour leadership and some Tories have all but endorsed the amendment, encouragin­g markets that it will pass and effectivel­y remove ‘no deal’ as a strategy from the Prime Minister’s negotiatio­n quiver – for now – leading to an undefined pause in the Brexit process or a ‘softer’ exit.

(January 25)

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