The latest UK political drama has shaken up sterling yet again, but the currency is still trapped in its narrow holding pattern, with some describing it as "impossible to trade" before investors have clear certainty on how Brexit will develop.
A run of defeats in parliament for Theresa May, forcing the government to publish its legal advice on Brexit, sent sterling sliding to its weakest point in a year and a half on Tuesday. But having hit a low of $1.2659 against the dollar, the pound has since picked up to trade over $1.27, still within the tight range it has held since mid-November.
After the publication of the UK government’s legal advice on Brexit, sterling was up 0.3 per cent for the session at $1.2757.
Against the euro it is trading at 89.05p, up from an earlier 89.32p.
The repeated failure of sterling to carve out meaningful direction either higher or lower indicates that investors are still in the dark on how the divorce from the EU will develop, with all options from no deal to no Brexit still seemingly in play.
"Each new development in the Brexit process contains multiple new permutations of upside and downside sterling risks that are purely impossible to trade at this point," said Stephen Gallo, head of forex strategy at Bank of Montreal.
Beneath the surface, however, the options market, which enables investors to either hedge against big sterling moves or to profit from them, is showing strain.
Implied volatility
Three-month implied volatility – a measure of expected risk running toward the fixed Brexit date of March 29th, 2019 – has hit its highest level since the immediate aftermath of the Brexit referendum, up 1.1 per cent to a reading of 13.6. At the same time, one-month implied volatility fell, showing that investors’ attention is moving towards Brexit’s climax next year.
“The market anticipates a significant sterling move at some point, and you can see this in the way that three-month implied volatility is going ballistic,” said Mr Gallo.
“But spot FX investors are not going to pile into the directional trade until the Brexit path is completely clear. Our view is that the risks for the pound will ultimately crystallise fully on the downside.”
After Wednesday’s publication of the legal advice, the next expected milestone is next week’s vote on May’s Brexit deal.
Ulrich Leuchtmann, of Commerzbank, predicted a "gradual recovery" for the pound in the event of a vote in favour of the prime minister's plan, and a "strong sell-off" without one.
“While it is a realistic option that parliament will reject the Brexit deal on December [11th], the market still expects the British government to come up with a solution to prevent a chaotic exit from the EU on 29 March 2019.” – Copyright The Financial Times Limited 2018
