FxWirePro: Two significant questions to strike a chord for long-tenured sterling vols

Prime Minister May surprised the market by calling for a snap general election on 8 June.

The possibility of a hard Brexit has already been discounted by the market, but the larger parliamentary majority currently implied by the polls would strengthen the UK government’s negotiating position domestically.

The market is now assigning better odds to a post-Brexit EU-UK trade agreement, and thus the worst may be behind us and cable short covering may just be starting.

For longer-expiry GBP vols, two questions are more pressing:

Firstly, whether snap elections constitute a game changer for the medium-term sterling trend –a 180-degree turn in a long-held macro view, especially from deep levels of currency under-valuation, can drive vol materially higher via sustained directional demand for options as we learned from the Abenomics experience; and

Secondly, whether relatedly, fundamental sterling FX uncertainty has increased even as domestic UK political uncertainty has decreased, as anecdotally indicated by the dispersion of views in internal and client conversations on implications of a larger Tory majority for actual Brexit negotiations.

The jury is still out on both questions and there is little sense in risking vol shorts this early in the game and this side of French elections, especially when current implied vol levels do not offer particularly outsized compensation to assume that risk (EURGBP 1Y ATM below 8%, near 2-yr lows).