Pound Falling to Parity Is an Idea That’s Starting to Take Hold
Suddenly, the idea of pound parity seems less far-fetched as the risk grows that Britain may split away from the European Union without a deal.
Rupert Harrison, a fund manager at BlackRock Inc., is short the pound and sees the risk of it falling to trade level with the dollar on a no-deal Brexit. The view echoes Morgan Stanley’s recent forecast that the currency can plunge toward $1 on such an outcome. That isn’t the majority view yet -- a Bloomberg survey this month estimated the pound will slide to $1.10 should the U.K. exit the bloc without an agreement.
New Prime Minister Boris Johnson has repeatedly said that Britain will leave the EU on the Oct. 31 deadline with or without an agreement, fueling concern the nation is headed for a disorderly departure and fanning pessimism toward the pound. Sterling has fallen more than 7% in the past three months, the worst performance among major developed-market currencies.
“The pound is at a much lower level now but I still think a no-deal exit would lead to significant volatility and we could be testing parity on a really bad outcome,” said Harrison, who manages more than $10 billion in assets at BlackRock. “We will see this game of chicken continue through August and that’s likely negative for sterling,” he said about the deadlocked Brexit talks.
The pound fell 0.8% to $1.2033 on Friday, its weakest closing level since the 1980s, after a report on the second quarter showed the U.K. economy shrank for the first time in six years. The data mean that it is likely that the Bank of England will cut interest rates, according to Mizuho.
The BOE said in November that the currency could fall even below $1 in an analysis on possible worst-case Brexit scenarios. Options-based calculations showed around a 6.4% chance of pound-dollar parity in the next one year, markedly higher than 0.2% in early March when prospects of a no-deal outcome were seemingly off the table.
There is a 30% chance that Britain will exit the bloc in October without a divorce agreement, a Bloomberg survey of 13 banks showed last week. That’s more than three times the level from a similar poll in February. In the latest survey, strategists assigned only a 15% probability to the prospect of a deal being struck by the deadline.
Sterling, and not U.K. bonds, offers the “cleanest” way to trade Brexit risks for BlackRock’s Harrison, who has had a short position in the currency for more than two months and is also using option strategies that benefit from an increase in volatility. His central case for the U.K.-EU split was one where he sees the current deadlock between the two sides persisting.
Option prices and sterling’s trade-weighted suggest the market is still not adequately pricing in the risk of a no-deal exit, according to Allianz Global Investors portfolio manager Mike Riddell, who said that’s making him “fearful” about the currency’s prospects. Six-month implied volatility in the pound-dollar pair is still close to the past year’s average.
“My core view is there will be some kind of extension that is just about the most likely outcome, but I am far less confident in that than I was at the beginning of the year,” said Riddell. “I thought there was just a 5%-10% chance of a no-deal Brexit by the end of March whereas now I think it is close to 50-50. Markets should be more worried.”
The pound could slide 10% in the absence of a deal by Oct. 31, according to Riddell. A political turmoil that might potentially ensue would boost the odds of opposition Labour Party leader Jeremy Corbyn becoming the next U.K. prime minister, which may see sterling sliding to $1, he added.
Riddell was bullish on sterling from late 2018 and through the first quarter of this year, before flipping his view on becoming “increasingly worried” about the hard-line stance adopted by candidates who were then running to succeed Theresa May as prime minister. BlackRock’s Harrison also started betting on pound declines two-to-three months ago when he expected Johnson to double-down on his no-deal rhetoric.
While the U.K. currency will likely jump if a deal passed through the House of Commons, Harrison is skeptical that the path beyond would be far from clear.
“There is a way of threading the needle that provides an upside sterling risk but I would not make that a central case,” he said.
©2019 Bloomberg L.P.