FxWirePro: Is Sterling vulnerable? Mounting hedging sentiments on Brexit negotiations in Brussels

GBP OTC hedging sentiments are intensifying due to the Brexit negotiations in Brussels – and the EURGBP exchange rate is trading above the 0.92 mark. Is this the beginning of a significant collapse of the British currency? Not yet, but the risks are rising.

Even if was never our central scenario we have always pointed out the risk of further notable Sterling depreciation.

In our view, the reason behind this risk is the country’s high current account deficit (almost £17bn. in Q1/2017 alone). This deficit has to be financed with the help of capital imports. In a situation such as this depreciation expectations can turn into a self-fulfilling prophecy if the capital inflow is reduced, the currency depreciates and these concerns fuel themselves. So far this has not been the case.

The Brexit referendum did lead to notable Sterling depreciation which led to a notable reduction of the current account deficit without such a self-propelling process taking shape.

However, the risks for the British currency are far from over. The current account deficit remains considerable and above all: the Brexit negotiations between the British government and the EU are difficult - to put it mildly. So far the market participants seem to be putting up with this in view of the fact that there is still plenty of time for the negotiations.

GBP OTC markets buzz with bearish hedging sentiments:

Please note that the nutshell showing the shift in delta risk reversals of GBP has been indicating downside risks in the weeks to come.

IVs have been stable with positively skewness for OTM put strikes that signify the hedgers’ bearish interests.

Mounting negative delta risk reversal can be interpreted as an opportunity for put longs as the market reckons the price has downside potential for large movement in the days to come which is resulting option holders’ on competitive advantage.

Hence, we advocate weighing up above aspects by eyeing on loading up with fresh delta longs for long term hedging in option spread strategies, more number of longs comprising of ATM instruments and OTM shorts in short term would optimize the strategy.