FxWirePro: Sterling gets little traction in OTC markets from “deal or no deal” scenario to no deal Brexit voting

The set of possible ends to the Brexit drama seems to have become smaller last night. Whereas before there were three elements: (“deal“, “no deal“, “no Brexit“) only the options starting in “no” seem to be left now. Of course “no deal” (i.e. a disorderly UK exit from the EU) is the less likely of these two possibilities. The only thing is: this likelihood has risen as a result of the House of Commons vote yesterday. Let us quickly glance roughly in our heads: “deal“ and “no Brexit“ would both be GBP positive, “no deal“ would be GBP negative. 

The likelihood the FX market had previously allocated to “deal” now has to be distributed amongst the remaining two alternatives. Regardless of how one looks at it, the likelihood of the GBP negative scenario cannot have fallen and is likely to have risen to a smaller or larger extent.

GBP OTC outlook:

The positive bids in the shorter tenors have been observed to the bearish risk reversal atmosphere in the GBP OTC markets, this is interpreted as the hedgers are keen on bullish risks in the short-run, whereas the long-term bearish outlook still remains intact.

You could easily make out that the positively skewed IVs of GBP have been stretched out on the downside. Mounting bidding for OTM puts is interpreted as the hedgers’ interests for the downside risks.

To substantiate this downside risk sentiment, risk reversals have also been bearish.

We reckon that the sterling should not suffer like before, as the market has always ignored the fact that all the current BoE interest rate moves are due to a favorable result of the Brexit process. One should not disregard the Fed’s hiking cycle on the other hand.

So what is happening with the underlying GBP exchange rates? Well, don’t we all know that the FX market is very bad at pricing in political risks? Following the US Presidential elections in 2016, the dollar initially appreciated considerably – as if this US President would be capable of doing anything USD positive. It took months until the market had corrected this misjudgment. And after all, it took at hours until Sterling came under pressure following the 2016 Brexit referendum. So in that way, yesterday’s market move is an ideal opportunity for all those who want to reduce their GBP positions in view of the no-deal risks. 

Hence, it is wise to capitalize on ongoing rallies and bid 1w/3m OTC indications to deploy theta shorts in short run (1m IVs) and 3m risks reversals to optimally utilize for delta longs. Courtesy: Sentrix, Saxo and Commerzbank

Currency Strength Index: FxWirePro's hourly GBP spot index is inching towards 133 levels (which is bullish), and hourly USD spot index trending at 28 (mildly bullish) while articulating (at 13:34 GMT). 

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