Brexit Noise Is Just Background Music for Sterling Traders Now

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(Bloomberg) -- Brexit has taken a back seat for traders and fund managers trying to predict the pound’s outlook over the next few months.

Implied volatility in sterling is the among the lowest in the Group-of-10 countries over the next three months. This despite the failure of the third round of separation talks with the European Union this week, a possible threat to Prime Minister Theresa May’s leadership at the Conservative Party Conference next month and an October EU summit where leaders will decide if sufficient progress has been made to proceed to the next phase of negotiations.

The reasons are more fundamental, traders said. Bank of England interest-rate expectations have slipped in the past month and U.K. economic data has been disappointing recently. While these are inextricably linked to how Britain and the EU hammer out the terms of their divorce, markets are now treating the day-to-day headlines as nothing more than noise. For the next few months there likely will be a dearth of substantial news, said James Hassett, head of FX trading at Barclays Plc.

“The feeling is just that things are going to get pushed out further and further,” Hassett said. “For sterling to rally, markets would like to see some definitive trade agreement. That looks like a long way off now and price levels reflect this lack of certainty.”

Hassett pointed to the forward volatility curve, which signals the market “is looking for more action next year as we get more specifics around Brexit negotiations.”

The spread between one-year and three-month implied volatility in sterling against the dollar has widened since June 1, which means markets are pushing the risk of price swings further out. The gap was at around 100 basis points Thursday, compared with 35 basis points in June and minus 28 basis points in January. The pound was at $1.2949 as of 12:51 p.m. in London. Sterling saw a drop of more than 2 percent against the dollar last month, its worst performance since October.

“We are not worried about specifics at all,” said Russell Silberston, a portfolio manager at Investec Asset Management Limited that manages $124 billion of assets worldwide. “For us it comes back to fundamentals and valuations.” The party conference “might have a short-term impact but we aren’t worried about the half percent move in the currency. We are trying to capture bigger moves over multi-week views.”

At the conference last October, May surprised markets by indicating that Britain would prioritize cracking down on immigration over keeping single-market membership and EU laws. This spurred prospects of a so-called “hard Brexit’’ and saw sterling slump. The move was exacerbated by computer-initiated sell orders, leading to a flash crash in the currency. The pound hit a 31-year low of $1.1841 on Oct. 7.

Those kinds of dramatic changes are unlikely this time around, said Investec’s Silberston, noting that prospects of “new news” are significantly lower now.

“What can May say that can surprise us this time around?” he asked. “Unless it changes the end game, the number of possibilities the market is discounting, it’s short-term noise.”

The implied probability of a 25-basis-point interest-rate increase by year-end was 23 percent, according to MPC-dated SONIA, sliding from 50 percent before the BOE’s policy announcement on Aug. 3. The Citigroup’s Economic Surprise Index for the U.K. has remained below the zero mark since May, which means data releases have undercut forecasts.

The pound could slide further amid Brexit talks but it’s hard to know what will happen in the next one to two years, said Neil Dwane, a global strategist at Allianz Global Investors Capital LLC, which oversees 501 billion euros ($597 billion) in assets. “Yes, Brexit is a risk factor but there’s no wisdom with which you can price that.”

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