Uneasy Calm for Pound Investors as Brexit Deal Bets Pushed Back
(Bloomberg) -- Pound investors are learning the virtue of patience.
With another deadline seemingly missed for a Brexit deal heading into a European Union summit on Wednesday, investors are beginning to accept they may have to wait longer for clarity on a divorce. Sterling is holding its ground after rallying since mid-August, and volatility markets show traders are betting on a resolution --- one way or the other -- within two months time.
The peaks and troughs of the Brexit negotiations have left markets contending with a constantly shifting timetable. Sterling’s recent strength shows the market is looking through the comments from both sides after an impasse in talks at the weekend and still holding out for a potential deal this year.
“There is an awful lot of posturing but for once the foreign-exchange market is being quite grown up about it,” said Russell Silberston, a portfolio manager at Investec Asset Management, which oversees $141 billion globally. “I don’t think anyone really thought we were going to reach an agreement in October. Everyone knew this was going to be the time of maximum noise as we get close and that’s been reflected in volatility markets.”
Investors had been focusing on a dinner Wednesday, where they hoped U.K. Prime Minister Theresa May and her European counterparts would be able to hammer out agreement on the Irish border, the thorniest issue. But EU President Donald Tusk said on Tuesday that May needed a “creative” solution and his chief negotiator Michel Barnier said the two sides needed more time to reach a deal within “the next weeks.”
One-week sterling volatility options, a measure of bets on swings in the currency, slid this week, signaling the fading hopes of any immediate deal. By contrast two-month contracts, which would cover any special Brexit gathering in November as well as the next EU summit in mid-December, climbed to the highest since February. The pound is little changed this week at above $1.31.
“This muted reaction shows that market players have learned the political tactics of the Brexit process,” said Richard Falkenhall, a senior currency strategist at SEB AB. “Given that there seems to be time to negotiate until December, it was just too early to expect a breakthrough in talks this week.”
The market is split on what the final result will be, but either way the currency should see a sharp reaction. The pound could gain more than 2 percent to $1.35 if a divorce deal is agreed, according to strategists. A recent Bloomberg survey saw it slipping to as low as $1.20 if Britain crashes out of the bloc without an economic agreement.
Progress by the end of the year is crucial for Jane Foley, the head of currency strategy at Rabobank International. If a U.K.-EU summit scheduled for November doesn’t take place, she might look to revise her sterling calls lower. Nomura International Plc analyst Jordan Rochester agrees that November is the key, saying the lack of a summit then would be “a painful scenario” for markets.
Some EU countries want a summit in November irrespective of the outcome Wednesday, which could be about ‘no deal’ planning if there’s not much progress, according to an EU official speaking on condition of anonymity. If the talks drag into 2019 and look like failing, the EU might think about publishing its no-deal plan in January or February, according to the official.
“A no deal to my mind looks increasingly likely,” said Andrew Cole, a senior money manager with Pictet Asset Management Ltd, who is running a small short position on the U.K. currency versus the dollar. “There’s more downside risk.”
Investec’s Silberston, on the other hand, remains optimistic and is expressing this view by betting on higher gilt yields rather than the currency. An agreement should be positive for the economy and give the Bank of England more confidence to put up interest rates. But a deal “has to be” done by the end of the year, he said.
“We are running out of time and there is absolutely no doubt about that at all.”
©2018 Bloomberg L.P.