Brexit News Is Just Background Noise for Sterling Traders NowBy
Implied price swings in sterling among lowest in G-10 peers
Without ‘new news,’ traders focus on economy, interest rates
Brexit has taken a back seat for traders and fund managers trying to predict the pound’s outlook over the next few months.
Implied volatility in sterling is the among the lowest in the Group-of-10 countries over the next three months. This is despite the failure of the third round of separation talks between the U.K. and the European Union last week, and a possible threat to Prime Minister Theresa May’s leadership at the Conservative Party Conference in October. For markets, it’s fundamentals that will determine the pound’s course.
Waning expectations of a Bank of England interest-rate increase amid weaker economic data have been a bigger driver of moves in the currency than Brexit developments, according to Russell Silberston, a portfolio manager at Investec Asset Management Ltd., which manages $124 billion of assets worldwide. While the economy is inextricably linked to how Britain and the EU hammer out the terms of their divorce, markets are now treating day-to-day Brexit headlines as nothing more than noise.
“The feeling is just that things are going to get pushed out further and further” in the talks between the U.K. and the EU, said James Hassett, head of FX trading at Barclays Plc. “For sterling to rally, markets would like to see some definitive trade agreement. That looks like a long way off now and price levels reflect this lack of certainty.”
Hassett pointed to the forward volatility curve, which signals the market “is looking for more action next year as we get more specifics around Brexit negotiations.”
The spread between one-year and three-month implied volatility in sterling against the dollar has widened since June 1, which means markets are pushing the risk of price swings further out. The gap was at around 108 basis points Monday, compared with 35 basis points in June and minus 28 basis points in January. The pound was at $1.2947 as of 11:09 a.m. in London. Sterling saw a drop of more than 2 percent against the dollar last month, its worst performance since October.
“We are not worried about specifics at all,” said Investec’s Silberston. “For us it comes back to fundamentals and valuations.” The Conservative Party conference “might have a short-term impact but we aren’t worried about the half percent move in the currency. We are trying to capture bigger moves over multi-week views,” he said.
At the conference last October, May surprised markets by indicating that Britain would prioritize cracking down on immigration over keeping single-market membership and EU laws. This spurred prospects of a so-called “hard Brexit’’ and saw sterling slump. The move was exacerbated by computer-initiated sell orders, leading to a flash crash in the currency. The pound hit a 31-year low of $1.1841 on Oct. 7.
Those kinds of dramatic changes are unlikely this time around, said Investec’s Silberston, noting that prospects of “new news” are significantly lower now.
“What can May say that can surprise us this time around?” he asked. “Unless it changes the end game, the number of possibilities the market is discounting, it’s short-term noise.”
The implied probability of a 25-basis-point interest-rate increase by year-end was 23 percent, according to MPC-dated SONIA, sliding from 50 percent before the BOE’s policy announcement on Aug. 3. The Citigroup’s Economic Surprise Index for the U.K. has remained below the zero mark since May, which means data releases have undercut forecasts.
The pound could slide further amid Brexit talks but it’s hard to know what will happen in the next one to two years, said Neil Dwane, a global strategist at Allianz Global Investors Capital LLC, which oversees 501 billion euros ($597 billion) in assets. “Yes, Brexit is a risk factor but there’s no wisdom with which you can price that.”
— With assistance by John Ainger