Sterling volatility crowns Brexit unknowns
Sterling volatility is one sure thing whilst Brexit uncertainty reigns.
Sterling sellers take back control
That sterling has scaled a 3.8% advance and seen a 2.7% slide within a fortnight illustrates the slippery hold traders have of chances that Britain could avoid crashing out of the EU in 137 days. The latest Downing Street upset—yet another ministerial resignation on Friday—underscored the market mood yet did not create it. Note the pound traded against the dollar had already begun reversing a near-4% six-day ramp in the middle of last week. Hence, even with critical UK economic data out on Tuesday and Wednesday—UK employment and inflation data, respectively—Brexit will remain the preeminent influence. In the absence of clarity, that suggests the bias for the pound is almost inevitably lower from here. Any bounce on promising economic news is likely to meet renewed selling.
Downing St in defence mode
Predicting when key unknowns could be clarified is an appropriately murky exercise in itself. With Downing St in defence mode after last Friday’s departure, we've got to assume the chances of agreement on the current formula are lower, though we may not know for some time, if ever. A new three-pronged approach to avoid a hard border between Ireland and Northern Ireland (NI), the key unresolved part of a Brexit treaty, looked initially set to be discussed by Theresa May’s cabinet on Monday. The package reportedly comprises (I) an agreement to replace the NI backstop, (II) an extension of the UK’s transition period under EU rules, and (III) a new fall back “backstop”, including a UK-wide customs union. But Number 10 will be aware that if it inches much further to accepting conditions that other cabinet members find anathema, it risks seeing the upset escalate to a full-blown crisis. The DUP, the Northern Irish party that props up Theresa May’s government, called the outline a “betrayal”, adding further grounds for Downing Street to turn cautious. The PM’s office eventually denied that a cabinet meeting on Monday to approve the deal was ever scheduled.
Cable’s short-lived ‘Barnier bid’
Sterling did see some relief from its slump of as much as 133 pips on Monday, after the FT reported that the EU’s chief negotiator, Michel Barnier told EU ministers "the parameters of a possible agreement are very largely defined". The report also backed the notion that substantial cabinet discussions on the new package could begin on Tuesday, following its publication. Theresa May’s spokesman later expressed scepticism about the report. With even less certainty that an emergency EU summit pencilled in for some time between 18th and 21st November will take place now, markets are unlikely to position strongly for confirmation of an agreement between the UK and EU, much less one that wins cabinet backing. Indeed, one-week sterling implied volatility, the rate at which options project the pound will move over the length of the trade, has spiked on Monday. The most ‘vanilla’ one-month option also shows that volatility has now surpassed prior highs for the year in February that accompanied broader market turmoil. Under these conditions, the risk that sterling could revisit lows for the year around $1.26 marked in August, having narrowly avoided doing so last month, is rising.
Figure 1: price chart - sterling/U.S. dollar 1-month / 1-week at the money implied volatility
Source: Refinitiv/City Index
GAIN Capital UK Limited (trading as “City Index”) is an execution-only service provider. This material, whether or not it states any opinions, is for general information purposes only and it does not take into account your personal circumstances or objectives. This material has been prepared using the thoughts and opinions of the author and these may change. However, City Index does not plan to provide further updates to any material once published and it is not under any obligation to keep this material up to date. This material is short term in nature and may only relate to facts and circumstances existing at a specific time or day. Nothing in this material is (or should be considered to be) financial, investment, legal, tax or other advice and no reliance should be placed on it.
No opinion given in this material constitutes a recommendation by City Index or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person. The material has not been prepared in accordance with legal requirements designed to promote the independence of investment research. Although City Index is not specifically prevented from dealing before providing this material, City Index does not seek to take advantage of the material prior to its dissemination. This material is not intended for distribution to, or use by, any person in any country or jurisdiction where such distribution or use would be contrary to local law or regulation.