Pound left cornered as Brexit bugbears multiply

Bloomberg

Suddenly, a no-deal Brexit is just one of the many unknowns pound traders need to contend with. Now the risk of a second referendum or even another UK election needs to be taken on board by investors. The biggest worry is still that Britain will crash out of the European Union without an economic agreement, with talks deadlocked and time running out. Analysts surveyed by Bloomberg see sterling sliding almost 8 percent to $1.20 on such an outcome.
At its recent annual conference, the opposition Labour Party said it plans to vote down Prime Minister Theresa May’s exit agreement with the EU and push for a fresh national ballot, while seeing a second plebiscite on Brexit as a way of avoiding a chaotic separation from the bloc. Analysts in the Bloomberg survey see a 23 percent probability of a no-deal Brexit, slightly up from 20 percent in a similar poll held in July.
“The Labour party conference has been interesting since they may consider backing a second referendum,” said Jane Foley, head of currency strategy at Rabobank. “This adds more Brexit permutations for the pound but it does increase the chances of” a no-deal situation leading to a second referendum.
The increasing uncertainty is prompting some investors to opt to stay on the sidelines of the market or to trade through options, with volatility becoming more expensive as the Brexit deadline grows closer.
“Many clients don’t want to be involved,” Rabobank’s Foley said. “Those that have to, I would advise to be nimble.”
Even with multiplying Brexit ambiguities, the pound has gained over the past month. While this was partly due to dollar weakness, some investors see it as a sign that the market is still not fully awake to the risks. Sterling was around $1.2980.
“Over the summer, markets were strangely complacent on Brexit tail risks, both of the chance of no deal or the chance of a soft Brexit,” said Michael Riddell, a UK portfolio manager at Allianz Global Investors, who is opting for out-of-the-money call options to profit from a large, little-expected rally in the pound. “The market still appears a little complacent. The options market is pricing in more risk, but still not enough.”
Three-month sterling-dollar implied volatility climbed to 236 basis points over the realised measure last week, the widest premium since the Brexit vote in June 2016 but still well below the extreme levels seen then.
This suggests “a sizable depreciation of sterling in case of a no-deal Brexit that is roughly 10 percent as an initial reaction,” according to Thu Lan Nguyen, a strategist at Commerzbank AG.