FxWirePro: Sterling OTC seems to be uninterested in Brexit negotiations

Sterling OTC FX functions seem to be tepid, out of the limelight but underlying spot movements haven’t been out of the woods. Amid the consolidation phase of GBPUSD, it has bottomed out at 1.1986 levels and bounced back to the current 1.3066 levels (i.e. shy above 9% in just six and a half months).

After all, the so-called “Brexit bill” had already caused tensions ahead of the negotiations.

Still, it remains to be seen whether the two sides can agree on the size of the bill. The situation remains difficult for the GBP, however, as the recent reports of domestic political quarrels in the UK show. Chancellor of the Exchequer Philip Hammond had a few concerns during the weekend that some cabinet members were undermining his efforts to ensure a “soft” Brexit.

Despite this driving forces of cable, the 25-delta risk of reversals of GBPUSD have not been indicating any dramatic shoot up nor any slumps but bearish neutral (no fresh change in risk reversals has been observed), but seems to be one of the pairs to be hedged for downside risks as it indicates puts have been relatively costlier.

The risk reversal curve has been traveling in a linear direction, while spot curve is slumping downwards back to converge with the RR curve.

Brexit has hurt eventually no matter if it is going to be soft or hard exit: If we do see resilience for Sterling through 3Q, as UK data hold up, and if we also see the euro trade down to parity with the dollar over that timescale.

While the cable volatility surface has returned to levels seen at the start of the year overall, but risk reversals and butterflies are now excessively cheap: - The sell-off in the cable skew is exaggerated compared to ATM volatility, since the risk remains asymmetric on the downside; - The tail risk is mispriced, as the GBPUSD butterfly is now less expensive than the EURUSD butterfly, which is unsustainable given the GBP extra tail risk.