Traders are anticipating big swings in the pound, ratcheting up the cost of hedging against sterling volatility in preparation for fast-moving developments in the UK’s ever-more fractious relationship with the EU.
Theresa May’s Brexit speech that she will deliver on Tuesday has already caused big shifts in the pound, following weekend media reports about its likely content.
However, traders are now weighing up the impact of Donald Trump on UK-EU relations after the president-elect promised Britain a quick trade deal post-Brexit.
The currency market is also gearing up for the Supreme Court ruling on the government’s challenge to the High Court’s Article 50 ruling, which prevents it from bypassing parliament when it triggers the formal two-year divorce proceedings.
One-week implied volatility in sterling against the dollar, which measures demand for hedging options in the currency pair over the forthcoming seven days, soared to its highest level since the aftermath of the June referendum on EU membership.
After hitting a two-month high last week, the measure soared from 14.4 per cent on Friday to 17.86 per cent in early Monday trading.
“The shape of the GBP volatility curve reflects both the concentration of uncertainty in the near term (May’s speech, the Supreme Court ruling) and hope that some of that uncertainty will be resolved,” said Adam Cole, G10 foreign exchange strategist at RBC Capital Markets.
One-month implied volatility also rose, from 12 per cent to 13.33 per cent, its highest since October. Jane Foley, forex strategist at Rabobank, said that was a period when Mrs May’s Tory conference speech caused investors concern.
Mr Cole added: ““Very short-dated vol is both elevated by recent standards and also at a large premium to longer-dated vol.”
Sterling was relatively becalmed towards the end of 2016, but January has revived investor anxiety about Brexit outcomes, particularly the UK’s probable loss of single market access, dragging the pound 3 per cent lower since the start of the year and below the $1.20 level.
Analysts range widely in their forecasts for sterling, but in the main are bearish.
Deutsche Bank is targeting $1.10 and below, while Goldman Sachs has a 12-month forecast of $1.14.
JPMorgan thinks sterling will get back to $1.24 at year-end, but has a low conviction level and says the pound could rise or fall 5 to 10 per cent depending on the government’s strategic objectives.
The range of Brexit possibilities and their impact on the pound were summed up by Marc Chandler at Brown Brothers Harriman.
“It risks oversimplification, but a hard exit, which is understood to be the loss of access to the single market, is understood as negative for sterling, while developments that slow the process (like the Supreme Court decision expected next week) or cushion it (like a fast trade agreement with the US, that president-elect Trump indicated over the weekend) are seen as supportive for sterling,” Mr Chandler said.
Kit Juckes, macro strategist at Société Générale, said that he preferred to reserve judgment on the pound until further economic data had been published.
Mrs May’s two red lines — immigration and leaving the European Court of Justice — seemed incompatible with single market access, he said.
These would be a drag on economic growth, and confirmation in her speech would justify a negative knee-jerk reaction in sterling.
“But still, a significant move lower surely requires harder evidence of economic weakness,” Mr Juckes said.
