Pound's Stomach-Churning Ride to Get Worse as Brexit Vote Looms

(Bloomberg) -- At one point Friday, the pound swung between gains and a two-week low as traders parsed contrasting headlines about the progress of Brexit.

Those swings may be dwarfed next week as U.K. Prime Minister Theresa May puts her divorce deal to a vote yet again in Parliament. If May can’t gain the backing of lawmakers for her plans, she will hold a vote on avoiding no deal and another on extending Article 50’s March deadline.

Sterling has sold off over the past week as the mood music on the prospects of reaching a deal with the European Union before Tuesday’s vote has soured, with the U.K. so far failing to get the concessions it wants on the Irish border.

“Should next week’s votes prove to be insurmountable obstacles to May’s deal, we think the pound may struggle to perform until there is more clarity on the outcome of the Brexit process,” said Credit Agricole SA strategists including Valentin Marinov. Still, they “are constructive on the pound because we believe that even an imperfect Brexit deal would be preferable to a no-deal Brexit for the MPs.”

The most likely scenario, according to a Bloomberg survey of banks, is that May’s deal fails to pass and Parliament votes in favor of a delay to the process. This could usher in a pound move up to $1.33, according to the survey. That would add to the currency’s gains this year that have made it the best performer among Group-of-10 peers.

Optimism on this outcome could be short-lived depending on the EU’s response following any vote to postpone Brexit Thursday, according to Canadian Imperial Bank of Commerce’s head of Group-of-10 strategy Jeremy Stretch.

“Any sterling rallies on Thursday night on a vote to push back Article 50 could be compromised on Friday as the EU comes back with a demand saying this is the price you have to pay for an extension,” he said. “Maybe that price will be sufficiently worrisome to make the market reconsider.”

Implied volatility in the pound-dollar pair touched the highest since mid-January on Friday, as traders sought to hedge against price swings. Risk reversals, an options gauge of sentiment and positioning, are fairly balanced between pound calls and puts over one week. The Bloomberg survey found the pound could drop as low as $1.20 on a vote for no deal or rally to $1.38 if May’s plan unexpectedly goes through.

With continued uncertainty over what exactly will be offered to lawmakers on Tuesday, and faced with big swings whatever the outcome, some are still opting to stay on the sidelines. There was very little volume in trading of the U.K. currency in the past week, according to Aberdeen Standard Investments fund manager Luke Hickmore.

“It’s almost impossible to trade, certainly in spot markets, because invariably you are running into headline risk and that headline risk is so extreme that you can’t legislate for it,” said CIBC’s Stretch. “Outside of options it’s very difficult to play with any real conviction.”

To contact the reporter on this story: Charlotte Ryan in London at cryan147@bloomberg.net

To contact the editors responsible for this story: Ven Ram at vram1@bloomberg.net, Neil Chatterjee

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