Brexit Angst Leaves Almost No Currency Untouched With Days to Go

How Portfolio Managers Insulate Against Brexit Volatility
  • Loss-hedging costs rise as global figures warn of EU exit risk
  • Pound surges most since 2008 as opinion polls turn yet again

Brexit stresses are seeping into virtually every corner of the global foreign-exchange market.

Of 16 major currencies tracked by Bloomberg, all but three have seen a jump in the cost to hedge against big declines as Britain’s referendum on whether to stay in the European Union approaches. The pound posted the biggest increase, closely followed by its continental neighbors amid speculation a vote on Thursday to leave would encourage other countries to reconsider their own membership.

The jump in options costs is a sign that foreign exchange is reverting to what’s known as a risk-on, risk-off market, where moves have less to do with local fundamentals and are more driven by global sentiment. It also reflects how the U.K. campaign has become increasingly internationalized in recent days, with policy makers from Japan, Switzerland and the U.S. joining Bank of England Governor Mark Carney in decrying the potential consequences of a Brexit on markets and economies.

“When you have a risk-off trigger that’s big enough, there tends to be contagion -- it’s just the way it is,” said John Hardy, the Hellerup, Denmark-based head of foreign-exchange strategy at Saxo Bank A/S, who in February warned about the risks the vote posed for the euro. Following a sterling surge on Monday, his prediction puts the U.K. currency more than 4 percent weaker by year-end at $1.40.

QuickTake Will Britain Leave the EU?

Domino Effect

“The pattern we’ve established so far will probably intensify” on a vote to leave, Hardy said, “so you’ll see the Swiss franc being the strongest from safe-haven-seeking as an immediate reaction, and the euro less so because the questions for Europe will suddenly loom very large.”

For most currencies, the jump in options costs began about two weeks ago, when the June 23 referendum suddenly hove into view, accompanied by a series of opinion polls which, for the first time, showed the “Leave” camp consistently ahead.

By Monday, surveys signaled the “Remain” campaign was regaining momentum, sending the pound to its biggest advance since the financial crisis and spurring a global rally in higher-yielding currencies.

All About Brexit

Among the 16 major currencies tracked by Bloomberg, the only ones not to have seen an increase in bearish bets are Brazil’s real -- which has been rallying as the nation overcomes its own political upheavals -- the yen and the Swiss franc. The last two are traditional havens, whose costs of hedging losses have tumbled, just as the others’ surged to the highest in months or even years.

“We saw this move of people being more prepared when we saw this flip in the polls” toward a “Leave” result, said Ulrich Leuchtmann, Frankfurt-based head of currency strategy at Commerzbank AG. A Brexit vote “would create pressure on all the less-liquid currencies like the Swedish krona, Norwegian krone and the eastern European currencies.”

Leuchtmann, whose sees the pound ending the year at $1.47, said in an interview Wednesday that he hadn’t fielded a single client query that day that wasn’t related to Brexit. Sterling climbed 2 percent on Monday to $1.4638 as of 11 a.m. in London -- the biggest gain since December 2008.

Record Premium

The premium on one-month contracts to sell the pound versus the dollar over those to buy widened 2.7 percentage points from June 3 to June 14, when it peaked at 8.9 percentage points. That was the biggest premium based on end-of-day prices since Bloomberg started collecting the risk-reversals data in 2003.

The gap has since slipped back to 7.5 percentage points. Even with Monday’s rally, sterling is still the second-biggest loser among major currencies this year, though it’s now down less than 1 percent versus the dollar.

For more on analyzing pound options ahead of the referendum, click here.

The euro posted the next-biggest jump in the premium on bearish options -- a 2.2 percentage-point jump to a 4 1/2-year high of 3.3 percentage points last Tuesday. Europe’s shared currency was followed by its Scandinavian peers.

For pro-Europeans, the risk of leaving the world’s largest single market is that the EU buys about half of Britain’s goods and services. A Brexit is by far the biggest threat to the global economy, according to a Bank of America Corp. survey of money managers, while the International Monetary Fund published a report this weekend warning that the impact of a U.K. exit would extend beyond Britain. The “Leave” campaign has focused on the perceived pressures of immigration and ceding of sovereignty to Brussels.

Campaigning has now resumed after being suspended at the end of last week following the killing of British lawmaker Jo Cox.

Volatile Times

The pound has been bounced around by opinion polls throughout the referendum campaign, dropping as much as 6.1 percent year-to-date at the end of February, before briefly wiping out its 2016 decline twice last month as surveys suggested the “Remain” camp was gaining ground.

Sterling reached a more than two-month low on Thursday -- in a week when five polls in 24 hours showed the “Leave” camp pulling ahead. Yet as today’s rally shows, the result remains too close to call.

“After a leave vote, you could see a lot of crosses going to parity: euro-franc, probably euro-dollar and even pound-dollar,” said David Kohl, head of foreign-exchange research in Frankfurt at Julius Baer Group Ltd., the second most-accurate currency forecaster, which predicts a modest sterling rally if the U.K. remains in the EU. “And that means a 30 percent drop in sterling.”

Before it's here, it's on the Bloomberg Terminal. LEARN MORE