Daily Brexit update: Sterling slides but markets eye post-vote gains
As Britain’s Parliament edges towards a vote on one of the most contentious bills for decades, UK markets remain remarkably stable, but sterling’s easy ride is over. The pound traded against the dollar galloped almost 4% higher between the beginning of the month and last night as a series of House of Commons defeats will tie the government’s hands if it pursues a no-deal Brexit. At one point last week, premiums—or prices—of options with a one-month expiry or less fell to their lowest in six months. On Tuesday though, whilst the pound declined only modestly from Monday’s seven-week highs a tad above $1.29, implied volatility is resurgent.
On the one hand, whilst much of the market is now well-hedged for almost any eventuality. On the other, there are also signs of over-hedging. At their highs, ‘overnight’ GBP/USD contracts would only be profitable if the pound fell as much as 130 pips by expiry. Well, whilst the spot rate has descended steadily throughout the day, it is only just notching a 100-pip loss by late-afternoon. In short, the bet could turn out to be a pricey one with little or no winnings.
With the quickest trades now less attractive, it makes sense that demand for expiries further in the future is also rising. This points to our first takeaway: whilst market reaction to tonight’s expected government defeat may be tame, savvy investors are preparing for volatility to rise in coming days and weeks ahead as discussion of alternative Brexit deals or even no Brexit rises.
Yet while all option premiums have spiked, perhaps the most revealing thing about prices is that those for bullish bets (calls) are rising higher and faster than for bearish bets. Put another way, ‘insurance’ costs for GBP/USD rising now outstrip the cost to protect against GBP/USD falls. Hence our second takeaway: options markets appear to expect at the very least that a soft Brexit, and/or an extension of the Article 50 process is more likely than ‘no deal’ in March.
To be absolutely clear, since markets make bets on the future, but do not decide it, trading patterns predict nothing. They only tell us what markets expect to happen. What’s certain is that as Parliament debates and pushes for myriad possible scenarios in the days and weeks ahead, trading will remain at risk of large whipsaws in either direction, but the markets are now biased towards the possibility of a big sterling advance soon.
How this affects our Brexit Top 10 markets:
GBP/USD: Cable is still falling and was at the lows of the day a little while ago. It now threatens a $1.2724 support that last worked on 11th January. Next corroborated support at $1.2605
GBP/JPY: The pound is offside by 93 units vs. yen, having briefly snapped above the ¥140 psychological level. A likely next stop is the spike low of ¥132.28.
EUR/USD: Euro slumped after the latest set of bad news from the continents growth engine, Germany, which released a preliminary 2018 GDP assessment with weak details.
EUR/GBP: Euro can rally vs. sterling whilst the pound is constrained. Still, the rate has gained less than on most days this month, pointing to underlying sterling support. Technical support remains at 0.88p.
UK 100: The FTSE rose from the doldrums, partly on its long-standing inverse relationship with the pound, but also in step with global markets.
Germany 30: The DAX added a modest 0.3% for similar reasons though was capped by softening economic readings.
Lloyds: Lloyds, one of the FTSE’s most Brexit-sensitive stocks, closed exactly flat on the day before.
Barclays: Barclays fell just 0.01%, with a set of less than robust U.S. bank earnings on tap this week.
Shell: Shell rose in line with large global blue chip shares, up 0.9%.
BP: BP gained 0.4%, with resilient oil prices also helping.
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