Pound Cheers Less Chance of No-Deal Brexit. Gilts Underwhelmed

(Bloomberg) -- Pound sentiment has improved in recent weeks as Parliament attempts to take control of the Brexit negotiations, while inflation and gilt markets are reluctant to reprice toward a reduced chance of a no-deal outcome. Swaption implied volatility sees limited rates moves in the near term given the lack of political direction.

• GBP rates remain rangebound as the lack of Brexit clarity extends, leaving implied volatility continuing to be marked lower given the persistence of low realized vol and risk of theta losses on long gamma positions betting on the inevitable re-pricing in yields

• A revisit of 3m10y implied vol to near 2016 Brexit referendum levels (~6bp/day) will likely be realized on a no-deal outcome, with the chances of that looking set to be further reduced on the Cooper-Boles Brexit delay amendment, if passed
• An extension of Article 50 that prolongs the uncertainty may weigh on realized vol dependent upon the driver, while a deal outcome will see positive correlation of implieds to a jump in yields
• GBP inflation markets look increasingly elevated against limited underlying price pressures, slowing CPI on lower oil prices, falling expectations elsewhere and seemingly increased chance of delay to Brexit vs no-deal outcome
• The 5y5y RPI swap has scope for decent downside on a softer outcome, but the liquidity risk associated with no-deal limits an aggressive outright fade

• NOTE: Tanvir Sandhu is a global interest-rate and derivatives strategist who writes for Bloomberg. The observations he makes are his own and are not intended as investment advice

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