Who would have thought that more than two years after Britain voted to leave the European Union, the U.K. and EU still haven't reached a Brexit deal?
U.K. and EU officials gave themselves almost three years to negotiate a divorce settlement but with less than six months to go before next year's March 29 deadline, the possibility of no deal is growing. In fact, European betting markets show a 40 percent chance that the Brexit deadline will pass without a withdrawal treaty.
I believe the odds are closer to 20 percent, but it is important to understand how the financial markets will be impacted because the EU and U.K. are still deadlocked on two big issues with both sides refusing to budge.
An Extension Coming?
There's no doubt that if Britain leaves the EU without an agreement, it would be a mess. European professionals working in the EU will find their jobs jeopardized, the status of certain legal contracts would be unclear and Britain would be subjected to the EU's external tariffs. If this were to happen, the U.K. government may ask for an extension, or risk destroying the U.K. economy.
An extension would ease the slide but it will not prevent losses because the uncertainty will persist. In a blink of an eye we could see sterling fall 3 to 4 percent with more losses to follow, but that would only be if the U.K. throws up its hands and gives up on the negotiations, letting the deadline pass with no request for an extension. In this scenario, all U.K. assets will be punished with stocks and bonds falling sharply. The fear that businesses will move their operations out of the U.K. could send the FTSE down as much as 5 percent.
What's more likely, however, is that the negotiation drags on and the Prime Minister May is forced to ask for an extension. In this case, sterling will fall but the slide would be more gradual.
Deal or No Deal
Ongoing concerns about a no deal Brexit would still weigh on U.K. equities in the short term, but as they work towards an agreement, the lower currency will help support earnings and bolster business activity. We've already seen evidence of this over the past two years -- Brexit uncertainty stripped away 16 percent of the currency's value while the FTSE soared more than 20 percent. That's happening because investors believe that a deal will be made.
With the clock ticking, the pressure is escalating quickly because in reality, March 29 is not the deadline for Brexit. It's the day that the U.K. says goodbye to the European Union. A deal needs to be agreed upon and approved by both sides before that happens. The EU wants a deal by their Brexit summit on Nov. 17, but they could call a meeting in early March. The U.K. government, on the other hand, is legally required to reach an agreement by Jan. 21 or risk a change of direction by Parliament. So in reality, the U.K. has just over three months to make a deal.
A Smoother Exit
The good news is that the EU and U.K. are trying to find an amicable resolution to the Irish border and customs union. There's still a very good chance that before the end of the year a deal will be made, which would pave the way for a smoother exit. A full blown Brexit deal could send GBP/USD soaring. Stocks should perform well as the uncertainty that has been plaguing U.K. assets for the past two years is lifted.
Written by Kathy Lien. Read more from the author here.
(This article is sponsored and produced by CME Group, which is solely responsible for its content.)