Pound Optimism Growing as Banks Take No-Deal Risk Off the Table

(Bloomberg) -- The tide looks to be turning for the pound, as the Brexit narrative shifts from fears of crashing out of the European Union this month toward expectations for a deal or delay.

The currency is the best-performing in the Group-of-10 basket so far this year, with U.K. Prime Minister Theresa May having seen off a lawmaker rebellion by promising a series of Parliament votes just weeks before the exit date. Goldman Sachs Group Inc., Deutsche Bank AG and hedge funds have become bullish on sterling.

Pound Optimism Growing as Banks Take No-Deal Risk Off the Table

The pound has rallied more than 4 percent this year, though gains have been capped at around $1.32 in recent months as the risk of a no-deal Brexit loomed. Goldman’s market strategy chiefs point to the unwinding of hedges in the market as a reason to bet on further gains, while Deutsche Bank reckons investors’ Brexit scenario planning has shifted.

“With the risk of a no-deal Brexit now most likely off the table by end-March, as well as the increased effectiveness of coordination among pro-deal MPs, we see the price action” as justified, wrote Deutsche Bank macro strategist Oliver Harvey in a note. “A no-deal Brexit will only be possible at the end of March should the U.K. government actively adopt it as a policy.”

The key to this is May’s decision to offer lawmakers a say on what happens next if there is no agreement on her deal in a March 12 vote. There will be two further votes in Parliament in subsequent days, on no deal and on delaying Brexit.

The cost of hedging the risk of a no-deal Brexit has fallen significantly, with pound-dollar two-month volatility now at its lowest since October. The currency has become a consensus long position in the hedge-fund world, according to Aberdeen Standard Investments’ James Athey.

Still, not everyone is buying into continued pound strength. UniCredit SpA on Thursday recommended taking profit on a long trade via options, saying that while there is room for further pound appreciation if a deal is agreed there is also the risk of a correction on an extension.

A three-month extension “would likely be more damaging for the economy and could easily write off a Bank of England rate hike until much later in the year or beyond,” ING Groep NV strategists including Chris Turner wrote. “A longer extension, while potentially more politically awkward for the U.K. government, could see growth recover a touch in the near term as the imminent no-deal threat recedes.”

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