FxWirePro: Sneak peek into Sterling’s strength on momentary relief from Brexit, hedging sentiments intact

GBP’s performance in recent months was noticeable than analysts had anticipated on a blend of less immediate tail risk from Brexit (following outline political agreement in December over a stand-still transition once the UK leaves the EU next March until end-2020) and a more constructive central scenario for the economy and monetary policy. Of the two, a reduction in the Brexit risk premium appears to have been the more significant.

Nevertheless, the modest acceleration in UK growth to around 2% doubtless contributed to the reversal of speculative positioning in GBP from heavily short to heavily long (more so CTAs than macro investors we believe) as it led to a firming up of UK rate expectations (one and a halfhikes are now priced for the end of 2018, three and a half by end-2020) and the promotion of GBP to the vanguard of currencies where central banks are in the early stages of policy normalization.

Impressions though can be misleading, certainly as far as Brexit is concerned.

In our view, the medium-term prospects for Brexit and by extension GBP remain in a state of uncertain political flux. Investors may have assumed that a transition was a done deal but there are substantive aspects of the transition (the Irish border, migration) on which the UK and EU have not been able to agree (because they are so politically charged for a fragile Conservative government) and which prompted the EU’s chief negotiator to warn last week that a transition was not a given. A non-negotiated cliff-edge Brexit may be a very low probability event but that probability is not zero.

OTC indications (GBPUSD):

Let’s glance on sensitivity tool, there is no shift in risks reversals of GBP crosses in both shorter and longer tenors that indicates hedgers are factoring in above stated driving forces to their exposures, while the momentary bullish risks are seen in underlying spot FX prices, while long-term bearish hedging sentiments remain intact.

Positively skewed IVs of 2m tenors have been well balanced that signifies the hedging interests on both OTM put/call strikes that means the ATM instruments have a higher likelihood of expiring in-the-money, while balanced hedging sentiments on either side in comparatively shorter tenors are favorable to both call and put options holders’ advantages.

Whereas the 6m skews have still been indicating bearish risks, this stance is substantiated by the bearish neutral risk reversals that indicate hedgers still bid for downside risks. ATM IVs are still stuck between 8.10-8.30% ranges for 3-6m tenors.

Currency Strength Index: FxWirePro's hourly GBP spot index has turned to -98 (which is bearish), while hourly USD spot index was creeping up at shy above -62 (bearish) while articulating (at 08:29 GMT). For more details on the index, please refer below weblink:

http://www.fxwirepro.com/currencyindex

FxWirePro launches Absolute Return Managed Program. For more details, visit: 

http://www.fxwirepro.com/invest