Pundits puzzled by volatile pound
EU chief negotiator’s promise to the UK sends it soaring by more than 1 percent
THE next few months are going to be fun for pound traders.
Sterling’s volatility left political pundits scratching their heads last week as EU chief negotiator Michel Barnier’s promise to offer the UK an unprecedented partnership sent the currency soaring more than 1 percent even though he had said it before.
With both sides warning of the risk of no deal, investors are going to become increasingly sensitive to Brexit headlines.
“What is quite hard for markets to work out is how much of this is political noise and how much of it is genuinely moving the probability of no deal,” said Mike Amey, a managing director at Pacific Investment Management Company, adding that the fund is hedging risks by not having big sterling positions either way.
While market participants still see no deal as unlikely, it’s a prospect that is weighing on the currency as UK lawmakers return this week from a summer recess with little progress made. Any proposed Brexit deal would have to be voted on by parliament before the UK leaves the bloc in March.
The headlines will keep on coming. After UK Brexit Secretary Dominic Raab admitted that the October deadline for negotiating a deal may be pushed back, there is increasing talk of an extra emergency UK-EU summit in November, as well as the two meetings already scheduled for October and December.
Theresa May’s Conservative Party conference is also approaching. While the rumours of a leadership challenge that were swirling around the prime minister in July following a spate of resignations have largely dissipated, the September gathering is still on the market’s radar. Prominent party members remain opposed to her negotiating position.
“People get bearish ahead of party conference season,” says Investec Asset Management portfolio manager Russell Silberston, who has a neutral position on the pound and thinks that pricing is “skittish on headlines.”
Assuming May survives the conference intact, the clock will be ticking to get agreement on thorny issues such as the Irish border. Options gauges of volatility are seen rising.
The real event to focus on is a likely November EU summit as this will be the last practical time to hammer out a final agreement and get it ratified by national parliaments of all EU members before March 2019, according to Investec’s Silberston.
Allianz Global Investors’ UK portfolio manager Michael Riddell is opting for out of the money call options to profit from a large unexpected rally in the pound.
“Unexpected comments stating something conclusive have the power to cause far more dramatic moves,” said Riddell.
In the event the UK gets a deal by year-end, the pound should rally while gilts sell off. Yet most investors see bad news having more of an impact than good news. A no-deal scenario would see a sharp move downwards, while agreeing a deal would only result in a gradual upwards move as details would still have to be worked out, Pimco’s Amey said.
All of this, plus the likely torturous passage of the Brexit legislation through parliament, adds up to a difficult path for investors into the Brexit endgame.