Here's What Is Priced in for the Pound Ahead of the Brexit Vote

(Bloomberg) -- Traders are gearing up for the pound to extend its advance this year as they cut the chances of a no-deal Brexit scenario.

The market’s positioning is short on the pound, leading to the risk of a spike higher if traders are forced to unwind their bets against the U.K. currency following this week’s Brexit votes in Parliament. Demand for hedging has lifted a gauge of expected swings in sterling to the highest since a U.K. election in 2017, and signals the possibility of new 2019 highs being hit.

Options models show a near 10 percent likelihood of a rally to $1.40 within a month, a level last seen in April. That compares to a less than 2 percent chance of a plunge to $1.20. Technically, weekly chart indicators show bulls are in control, adding further evidence to the potential for gains.

Here's What Is Priced in for the Pound Ahead of the Brexit Vote
  • One-day volatility stands near 25 vols, for a breakeven of around 170 USD pips with spot at $1.3070, according to Bloomberg data.
  • According to Bloomberg’s FXFM model, over the next week, traders see a 17 percent chance that cable hits $1.35, while a move to $1.25 stands at 5 percent.
Here's What Is Priced in for the Pound Ahead of the Brexit Vote
  • One-week risk reversals, a gauge of sentiment and positioning in options, are trading near parity as investors see a Brexit delay as the most likely scenario if May loses Tuesday’s vote on her revised deal, with another vote in favor of extending Article 50 due March 14.
  • Further out, pound puts still trade at a considerable premium over calls, as the market assigns a risk premium over ongoing uncertainty.
  • This leaves room for an extended short squeeze in cable should the deal pass, as investors will need to unwind, at least partially, their lower pound hedging bets.
  • The market remains structurally short the pound, even as short-term accounts are consistently fading dips, according to three traders in Europe.
Here's What Is Priced in for the Pound Ahead of the Brexit Vote
  • Technically, the U.K. currency remains in a higher highs, higher lows pattern this year and a bullish engulfing line formed Monday on the daily chart suggests a fresh move north is in the making.
  • The first target is the $1.3350 Feb. 27 high, whereas strong selling interest could lie around $1.3637, the 61.8 percent Fibonacci retracement line of cable’s losses since April.
  • Dip-fading interest could accumulate around $1.2949-61, the March 11 low and 55-daily moving average; momentum indicators stand at neutral levels, leaving room for further gains; current price action satisfies an ABC correction of a Elliott Wave 1-5 minor cycle as the pound could be in a powerful Wave 3 of a move that started in early January to target $1.3858.
  • Some information comes from FX traders familiar with the transactions who asked not to be identified because they are not authorized to speak publicly.
  • NOTE: Vassilis Karamanis is an FX and rates strategist who writes for Bloomberg. The observations he makes are his own and are not intended as investment advice.
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