What’s Next after May’s Deal Rejected?

Last-minute negotiations failed to convince parliament to support Theresa May's Brexit deal in another blow for the pound. The New Zealand dollar was the top performer while the pound lagged. US CPI also missed estimates in another inflation miss. Reversal or Deferral are the remaining choices. The Premium trade on GBP remains open and in the green, so is the EURUSD trade. The charts below highlight the peak in GBP volatility, which is stabilizing for the currency.

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Getting a deal through parliament was a longshot as the week got underway but some optimism built after May secured some stronger language in a joint EU statement regarding an exit from the backstop. Those hopes were dashed by a statement from UK Attorney General Cox who said the UK could remain stuck in the backstop.

That headline triggered a drop to 1.3005 from 1.3160 and it was used by the DUP and ERG as justification for voting against the deal. The result was a 242-391 defeat for May. That's an improvement from 202-432 in January but still needs to switch about 75 votes to get a deal. It's tough to envision the EU offering much more of a sweetener so May will need to pull off some magic.

The pound initially bounced after the vote. That was partly due to some progress in the numbers but more so due to May announcing there will be a vote on leaving with no deal on Wednesday followed by a vote on extending Article 50 Thursday. She said the no-deal vote will be a free one for her party but it will surely be defeated by a massive majority.

The market is now pricing in an extension and reports suggest the government will aim for May 22. That votes in the days ahead should ease some of the nerves in GBP and provide a tailwind. Beyond that, the tail risk is that the EU makes an extension difficult by demanding further divorce payments or with a threaten to block it. An extension can only be granted by a unanimous vote of all 27 EU members so there's a chance a member could grandstand.

While Brexit headlines dominated Tuesday, there were some other notable moves. US CPI registered +1.5% y/y in February compared to 1.6% expected. The FX reaction was minimal but US 10- year yields fell below 2.60% to the worst levels since Jan 4. A fall below the Jan low of 2.54% would pressure USD/JPY.