Never-Ending Brexit Sends Traders to Distant Market Corners
(Bloomberg) -- As Brexit sends hedging costs soaring again, strategists are recommending a slew of less crowded ways to trade the never-ending political drama.
From euro-area bond spreads and equity derivatives to the shape of the inflation curve, investors can place bets on Britain’s economic future, without speculating directly on its volatile currency.
As the U.K. rebuffed the European Union’s effort to restart their deadlocked trade negotiations, Prime Minister Boris Johnson still held out room for more talks this year, spurring investors to prep for fresh political fireworks.
With that in mind, here are some alternative investing styles to trade the torturous negotiations.
For the deal pessimists, selling Irish sovereign bonds to buy French government debt looks like a good hedge, according to JPMorgan Chase & Co. Ireland’s economy is far more dependent on the U.K. than the latter’s continental neighbor, therefore its yield typically rises relatively more when no-deal talk pummels the pound.
Investors can make bets on the inverted correlation between the Irish-French bond spread and sterling, while deal optimists can go the other side of the trade.
In the equities world, one view holds that the FTSE 100 should suffer relatively less than the Stoxx Europe 50 Index on no-deal fears. That’s because a cheaper pound tends to cushion the impact on U.K.-listed multinational stocks, more so than the comparable dynamic in the euro-area index.
As such, sell-side strategists have recommended selling puts on the FTSE to buy them on SX5E. Right now, pricing appears to favor that trade with a benchmark put costing well above its five-year average relative to its counterpart, as measured in volatility terms.
Thomas Clarke, who helps manage $56 billion at William Blair Investment Management in London, said the firm recently increased a long position on U.K. stocks and trimmed a bullish holding in sterling. “A deal is more likely than none, but if we’re wrong, or there’s a bad deal, the equity market would be better protected than the pound.”
One wild trade lives in market-derived inflation expectations. Traders are expecting higher price pressures over the next five years relative to the next 30, spurring an inverted yield curve. Retail price inflation is currently seen around 48 basis points more than in three decades time, near historic extremes.
If there’s a deal, the inflation curve may pare its current inversion, according to Bloomberg Intelligence global derivatives strategist Tanvir Sandhu. Without deal, near-term inflation swaps may climb further, he said.
Morgan Stanley cross-asset strategist Andrew Sheets, for one, predicts a U.K.-EU deal in some form or another by early November, sending the pound back to $1.40 versus $1.30 currently. The upside for speculators is huge: The sterling options market on Monday flashed only a 2% probability this level would be reached by mid-November.
Any sterling-positive news in the weeks ahead therefore has the potential to jolt cross-asset trades, from bond spreads to inflation curves.
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