Pound Watchers Are Finally Embracing the Harsh Reality Ahead
Pound Watchers Are Finally Embracing the Harsh Reality Ahead
(Bloomberg) -- Traders have finally started to brace themselves for the risks that lie ahead for the pound.
Even though the currency is up against the dollar Friday, the cost to hedge against swings in sterling has risen, fueled by concerns over Brexit trade talks and fears of a second wave of coronavirus infections. While these risks aren’t new, volatility expectations had been relatively subdued since mid-April.
The market may have been jolted by the sharp sell-off in stocks on Thursday.
The pick up in volatility is pronounced on the three-week tenor, which captures the June 30 deadline for the U.K. government to extend the Brexit transition period beyond the end of 2020.
It is the first time options traders look to hedge this Brexit tail risk. The so-called forward overnight implied volatility, that essentially captures investors’ demand over the June deadline, is around 16%, compared to less than 11% on Wednesday.
U.K. Prime Minister Boris Johnson and European Commission President Ursula von der Leyen will hold a call on June 15 aimed at injecting momentum into the talks that are currently in a stalemate. They have six months to reach a new trade accord.
The so-called calendar spreads, that look to gain from mispricings around certain risk events, could come into play as the Brexit transition deadline approaches.
Data Blow
Economic data on Friday showed that the U.K.’s gross domestic product shrank a record 20.4% in April as businesses and workers reeled under the lockdown designed to control the coronavirus pandemic, effectively wiping out almost 18 years of growth in two months.
The data was largely in line with expectations, but if such releases were to spur more Bank of England policies -- such as the introduction of negative rates or yield curve controls -- then that, together with looming pandemic risks, could result in medium-term volatility, catching up with gains in the front-end of the curve.
Economists see the BOE expanding its bond-buying program and holding its key rates on Thursday.
- NOTE: Vassilis Karamanis is an FX and rates strategist who writes for Bloomberg. The observations he makes are his own and are not intended as investment advice
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