Pound Investors Face Months of Volatility Into Brexit Endgame

(Bloomberg) -- The next few months are going to be fun for pound traders.

Sterling’s volatility left political pundits scratching their heads last week, as European Union Chief Negotiator Michel Barnier’s promise to offer the U.K. an unprecedented partnership sent the currency soaring more than 1 percent even though he had said it before. With both sides warning of the risk of no deal, investors are going to become increasingly sensitive to Brexit headlines.

Pound Investors Face Months of Volatility Into Brexit Endgame

“What is quite hard for markets to work out is how much of this is political noise and how much of it is genuinely moving the probability of no deal,” said Mike Amey, a managing director at Pacific Investment Management Co., adding the fund is hedging risks by not having big sterling positions either way.

While market participants still see no deal as unlikely, it’s a prospect that is weighing on the currency as U.K. lawmakers return this week from a summer recess with little progress made. Any proposed Brexit deal would have to be voted on by parliament before the U.K. leaves the bloc in March.

The headlines will keep on coming. After U.K. Brexit Secretary Dominic Raab admitted that the October deadline for negotiating a deal may be pushed back, there is increasing talk of an extra emergency U.K.-EU summit in November, as well as the two meetings already scheduled for October and December.

Key events:

  • Sept. 4, 2018: Parliament returns from summer recess
  • Sept. 30-Oct. 3: Conservative party conference
  • Oct. 17-18: EU summit. Initial deadline for outline of deal on future relationship
  • Oct. 31: Original deadline for talks to be completed
  • November: Potential emergency summit, not yet confirmed
  • Dec. 13-14: EU summit. Seen as fallback option for finalizing deal
  • March 29, 2019: The U.K. leaves the European Union

Hurdles Mount

Theresa May’s Conservative party conference is also approaching. While the rumors of a leadership challenge that were swirling around the Prime Minister in July following a spate of resignations have largely dissipated, the September gathering is still on the market’s radar. Prominent party members remain opposed to her negotiating position.

“People get bearish ahead of party conference season,” says Investec Asset Management Portfolio Manager Russell Silberston, who has a neutral position on the pound and thinks that pricing is “skittish on headlines.”

Assuming May survives the conference intact, the clock will be ticking to get agreement on thorny issues such as the Irish border. Options gauges of volatility are seen rising.

The real event to focus on is a likely November EU summit as this will be the last practical time to hammer out a final agreement and get it ratified by national parliaments of all EU members before March 2019, according to Investec’s Silberston.

Allianz Global Investors’ U.K. portfolio manager Michael Riddell is opting for out of the money call options to profit from a large unexpected rally in the pound.

“Unexpected comments stating something conclusive have the power to cause far more dramatic moves,” said Riddell.

Asymmetric Risk

In the event the U.K. gets a deal by year-end, the pound should rally while gilts sell off. Yet most investors see bad news having more of an impact than good news. A no-deal scenario would see a sharp move downwards, while agreeing a deal would only result in a gradual upwards move as details would still have to be worked out, Pimco’s Amey said.

Silberston agrees, seeing failure to strike a deal leading to a “quick re-pricing, just as we saw in June 2016.” The pound fell more than 8 percent versus the dollar on June 24, 2016, the day of the Brexit vote result.

All of this, plus the likely torturous passage of the Brexit legislation through parliament, adds up to a difficult path for investors into the Brexit endgame. Faced with high levels of uncertainty, many fund managers are staying cautious.

“It’s very hard to invest when you have no more insight than anyone else regarding how the negotiation turns out,” said Paul Lambert, head of currency and portfolio management at Insight Investment, who is neutral on the pound. “You could guess and you might be right, but it would be little more than a guess.”

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