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The pound is rising because the market hopes that Labour leader Jeremy Corbyn will be able to prevent a no-deal. Yesterday, he met with other parties of the opposition in order to find common ground. There were assurances of cooperation, e.g. by means of legislative proposals or a vote of no confidence. The market reacting in a pound positive way to the oppositions’ meeting shows just how desperately it is hoping for a happy ending.
But the risk of a no-deal is still very real. Parliament returns from summer recess next week and the nerve-racking battle about a soft Brexit will go into the next round.
Like most mortals, we have no insight on how the long-running Brexit drama will resolve. All we can say with a degree of confidence is that should the UK crash out of the EU without a deal, currency markets stand a good chance of directionally reprising the price patterns observed in the aftermath of the 2016 referendum.
EURUSD dropped 1.5% in the 3-months following the shock result and a more substantial 8% in 6-months; EURGBP climbed north of 10% over this period, much of it on the day of the vote; and the realized correlation between the two fell to as low as -90%.
Yet EURUSD vs EURGBP 3M implied correlation today is marked at +14%, Euro has an independent bearish catalyst at play in the form of potentially ECB easing including QE in September, and the pricing of bearish Euro options is sweetened by multi-year highs in forward points.
Consider the following as no-deal Brexit trade: 3M (EURUSD < 1% OTMS, EURGBP > 2% OTMS) costs 11% (individual digitals 26% and 34.7% respectively). Courtesy: JPM
