Disunity, discontinuity and debt deboning

Who remembers Brexit?

Seems like it was a long time ago now, doesn't it?

Do you remember the super gonorrhoea we were meant to get?

The queues upon queues of people trying to leave or get in or whatever the kooky Remainers had concocted in their heads?

Or how London was set to be destroyed as a financial hub?

Yeah, I remember all of these things, but it's quite funny how none of them came to light, right?

We saw, of course, some disruption, but as with anything new that occurs, that's life.

It happens.

But there is a chasm between the predicted doom and the reality.

Markets are one of the best barometers of signifying hysteria.

Take the recent MemeStock mania.

Here's $GME.

My memory must be absolutely battered, because I thought this run up took weeks, not FOUR days.

The collapse took roughly the same amount of time.

Then we didn't see all time highs hit again.

This brings me onto the meat of what I want to talk about today...

Land of hope and glory

Of course you know which country I'm referring to here.

France!

PAHAHA.

No, obviously the UK.

And more specifically, the euro versus the pound.

Something caught my eye when taking a peak at the chart and got me thinking about reversions to the mean, obtuse pessimism and changing contexts, which I'm going to outline as you read.

But first, a chart to provide a foundation.

Much like the DAX trade (just on a broader time scale of YEARS, rather than one year) it definitely seems to have topped.

But key for me is the 'hysteria' candle on the 24th June, 2016 that you can see in your chart, the day the UK voted to leave the EU.

Let's face it, the chart looks Didier Dogshit from a price perspective and we can start thinking about factoring out pessimism.

Ask yourself this...

'Why if the prospects of the UK leaving the EU for the long term are SOOOOO bad, are we now trading under the referendum high?'

Shouldn't we be trading closer to parity and above?

And this is also taking into consideration that sterling is a higher beta currency, which tends to move in line with risk - and currently, the risk backdrop is in the toilet.

Moving further with factoring out pessimism, we can ask ourselves some more questions.

Do we think how the EU behaved during the pandemic could be considered conducive to a good union?

There was bickering, slow moving and issues with the QE programme that had been brought to the German High Court, which admittedly were thrown out, but still.

More recently, we saw more complaints over how Russia would be sanctioned, with Italy demanding they could still send luxury handbags to the Kremlin's WAGs (wives and girlfriends, for those unfamiliar with England's Euro 2004 folklore).

I'm simply setting the scene here - that the issues that the EU has always faced, where, when faced with crises, there are disputes, have come to the foreground EVEN MORE over the last couple of years.

And what is becoming very interesting is how the EU handles Ukraine's application for membership.

I feel like it seems all rosy now, but there's going to be big bust ups over this if and when the crisis cools down.

Imagine you're a country that has/had been waiting for years and the EU bends the rules to expedite membership.

Or on the flip side, if the EU does grant membership, what does that mean for defence going forward, since Russia had invaded an EU member state?

Do current member states want to get involved in this when the hysteria dies down (in this case, I think the hysteria is right, by the way).

And finally, coming out of both the pandemic and now this change in geopolitics, what does it mean for the stability and growth pact?

We touched on this back in October...

Essentially, all the EU member states have to abide by a measure of no more than 3% deficit spending and 60% or less debt to GDP.

The pandemic has clearly blown through that and there is currently only ONE country in the EU that is not in breach of the excessive deficit rules, Sweden.

Apologies, the chart might be difficult to see, but you can view it here as well.

What I am getting at here, is that the EU has a changing picture coming, and when you consider that Brexit was meant to be such a broad based changed to status quo, you can also take into account that what is coming for EU governments is just as much a large change in status quo too.

If you're moving the goalposts, this does not provide unity and coherence in future policy, and creates uncertainty.

What is also concerning here is if the EC decides that overly indebted nations have to now cut back - austerity - which we saw earlier last decade.

It began in 2010 as a result of the GFC.

But the focus here is less on the austerity and more on the discontinuity that Europe might face, and as a result, where the euro versus GBP is headed to.

In this case, I really reckon the base of the 'hysteria candle' of the Brexit referendum is a great long term target, which is about 0.76.

Factor in as well how the UK has been able to raise rates marginally, whilst the Eurozone seems stuck, and we start to see the rate differential factor come into play too.

In all, I don't think the euro is in for a good ride and the future narrative of how the EU behaves is the driving factor.

In one line then, 'disunity, discontinuity and debt deboning' are the driving factors for my pessimism on the pair.

Risk is skewed to the downside as Brexit problems have faded, and EU specific risks are now in play.

Trade well.