The irony of British stock and bond markets plus sterling trading in largely sanguine fashion ahead of a vote of no-confidence in the government is something to savour, although we know why. It was underlined last night, soon after the government’s Withdrawal Bill was defeated. The Democratic Unionist Party, which props up Theresa May’s minority government but is one of the most vehement opponents of Theresa May’s Brexit deal, pledged to support her in the confidence motion. That’s pragmatic. If the DUP chose not to back May it would be back out in the cold. Other government-supporting Brexit opponents have signalled similar intentions and, it looks like similar motivations apply.
This is, essentially why Theresa May’s government is widely expected to win the confidence vote. But broad consensus presents a conundrum for traders. Perceived certainty about tonight merely delays a more fundamental lack of visibility.
As such, as noted in yesterday’s update, not only does the market have to deal with the usual myriad possibilities, investors are also increasingly wary about hedging or speculating costs amid frequent inflection points. This was epitomised last night. Short-term option costs shot higher, requiring the pound to surge hard to justify pricey premiums. That’s another disincentive that’s here to stay as multiple scenarios come into play after tonight’s likely government win.
The main way this perspective would change is if the government and Parliament stumble into a no deal Brexit by 29th March. In fact, risks of that may be heightened by a government win tonight if no new consensus emerges that Parliament can get behind and this precipitates a failure to extend the Article 50 process.
This is why we expect longer-dated options to return to the spotlight in the weeks ahead. But there’s another advantage to holding them too: premiums (costs) have tanked. A 6-month 1.20 GBP/USD put would tax you about 150 pips today versus 250 last month. The most applicable option term, three months, has tumbled 22% since fervent 18-month highs in mid-December. With tonight an almost dead cert but the next few months anything but, it would be remarkable if investors didn’t swoop on sharply discounted longer-term hedging and speculating prices.
How this affects our Brexit Top markets:
GBP/USD: Sterling is literally flat against its Tuesday close as I write. Expect this to continue till the vote. Afterwards it should rally moderately on a government win, perhaps setting a new high of the day above the prior one of $1.2895. The broad range will hold. In the unlikely event the government loses, sterling’s tumble could be spectacular. Expect a 200-pip move at least.
GBP/JPY: Usually the most volatile pair but today showing hardly any drama. Nudging 140 as I write, it will pass that and some on a government loss but revert rapidly to range. It should plummet to 135 at least if Theresa May loses.
EUR/GBP: Sterling in a fair rally vs. euro but well within its weekly and monthly range.
UK 100: The FTSE struggles with the pound so irrepressible.
Germany 30: DAX has been hamstrung by data this week hence was prone to catch the coattails of the latest global market bounce.
Lloyds: Lloyds shares rising by 1.2% underscores cross-market optimism that no shocks will emerge tonight.
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