Investors Get Blindsided by Vanishing Odds of Brexit Deal
The pound had hit a two-year high and the FTSE 250 Index of mid-cap stocks was coming off its best month in a decade.
Just a week ago, U.K. markets were telegraphing that a Brexit deal was in the cards after months of torturous negotiations.
The pound had hit a two-year high and the FTSE 250 Index of mid-cap stocks was coming off its best month in a decade. In one of the bolder sell-side calls of late, Goldman Sachs Group Inc. declared British assets a buy, projecting sharp gains in the pound and stocks.
Now, prospects of a trade deal with the European Union are seemingly vanishing. On Monday, a British official warned talks could collapse unless negotiators make progress in the next few hours, and a spokesman for Prime Minister Boris Johnson ruled out the possibility of talks continuing next year.
“It now appears investors have been caught very much off-guard,” John Hardy, head of FX strategy at Saxo Bank, wrote in a note.
The pound slid 0.9% against the dollar and the FTSE 250 lost 1.1% on Monday. Here are a few charts that show investors have been positioning for a deal:
Fund Flows
U.K. mid-cap stocks have been absorbing plenty of cash, partly driven by a rally in value stocks around the world.
The Vanguard FTSE 250 ETF has taken in 240 million pounds ($319 million) in December alone. That puts the fund of British midcap stocks on pace for its best month in a year, and follows a 145 million pound inflow in November.
Pound Positioning
Hedge funds and other speculators have pared their short in the pound recently, with the latest data from the Commodity Futures Trading Commission showing a move back toward neutral positioning. Meanwhile, the cost to guard against further swings in the U.K. currency has surged.
“In the case of no deal, we expect a profound GBP collapse -- EUR/GBP above 0.95, possibly briefly touching parity -- due to the fact that this outcome would come as a surprise and investors have not been pricing this in,” ING Groep NV strategists including Petr Krpata wrote in a note.
Options Markets
Sterling and the options market are now moving in-tandem, suggesting hedges in the run-up to this seemingly make-or-break week are proving insufficient.
“The move in GBP illustrates that the market is reviewing its expectations of the chances of a deal,” said Jane Foley, head of FX strategy at Rabobank. “My personal view is that it is 50:50. We can not under-estimate the importance of sovereignty to the U.K.”
Still, many investors say they’re still expecting a deal -- even if it comes down to the wire.
“We still think there’s a better probability that we get some kind of deal before the deadline,” Scott Thiel, chief fixed income strategist for BlackRock Inc., said during a press conference with reporters on Monday. “It’s very difficult particularly in a political negotiation process like this to understand a particular dynamic, particularly as it becomes very close to the end.”
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