British Pound Lifted by Vaccine Risks Brexit Fallout

(Bloomberg) --

It’s back to looking at Brexit for traders gauging whether the pound can keep surging.

Sterling has been one of the main beneficiaries of the growing optimism for a Covid-19 vaccine, which would boost a services-driven U.K. economy stifled by lockdowns and diminish the likelihood of negative interest rates. The pound and government bond yields have been rising in tandem, with some banks seeing sterling reaching a two-year high of $1.40 if there’s a Brexit deal.

Sentiment in options and on technical charts has also turned more positive heading into the final days of Brexit negotiations, as a last-minute agreement remains the base-case scenario for most banks. Yet the risks were shown by headlines Wednesday warning a mid-November deadline is likely to be missed, contributing to a pound drop that halved this week’s gains.

“If the U.K. and EU can agree a trade deal this week, I think there’s a chance of the pound trading at $1.40 by the New Year as talk of negative rates melts away,” said Kit Juckes, chief currency strategist at Societe Generale SA. “‘If’ though, is a poor trading strategy.”

That’s because markets betting on Brexit resolutions have been caught out before. Saxo Bank’s head of currency strategy John J Hardy said the pound could fall to as low as $1.20 without a deal. Sterling is still up about 2% this month after its dip to near $1.32 on Wednesday. Against the euro, it’s rallied 1.5% this week to 88.94 pence, touching the highest since June.

The FTSE 100 Index has soared 14% this month, and U.K. stocks outperformed other major European markets Wednesday.

Deadline

While traders have shrugged off the passing of some recent deadlines, now there’s a sense that time really is running out. The European Union and U.K. have previously indicated that Nov. 15 is the last moment a trade deal can be done if it is to be ratified by their respective parliaments before the transition period ends on Dec. 31. The EU parliament’s late November plenary session may offer a few more days grace.

READ MORE: Pound Options May Offer Clear Theme on Brexit Talks

Otherwise the U.K. would formally leave the European single market, causing global market volatility and disruption for local businesses. Further pressure to get a deal has been added by the recent U.S. election result as British Prime Minister Boris Johnson tries to avoid a rift with President-elect Joe Biden that could stymie the chances of a U.S. trade deal.

“The pound needs that Brexit breakthrough headline,” said Saxo’s Hardy. “1.3500 is the big focus for cable, freeing up possibly 1.400.”

Even with the time pressure, options traders are optimistic. Risk reversals, a barometer of positioning and sentiment, have turned in favor of pound gains over one week. Longer term, they signal bets on a weaker currency given the prospect of more monetary stimulus by the Bank of England and the fragile state of the U.K. economy.

On price charts, the pound-dollar pair closed Tuesday above its 50-, 100- and 200-day moving averages while euro-sterling finished below the same three indicators -- the first time that’s happened since February.

Priced In

A Brexit deal has been priced in to some extent, as so-called butterfly options over one month -- revealing traders’ demand for hedging against large price swings -- are well below their year-to-date average. A Bloomberg options pricing model only suggests about a 25% chance of a sharp shift above $1.40 or below $1.26 in a year’s time.

Yet an agreement together with vaccine progress would be a double boost, also drawing money back into the U.K’s battered stock market.

“The strength of the pound is attracting attention,” said Stephen Innes, a strategist at Axicorp Ltd. “The U.K. has struggled the most among G-10 peers to cope with the pandemic, and therefore stands to benefit the most from a vaccine given its large servicing sector.”

©2020 Bloomberg L.P.