LONDON (Reuters) – Having sunk to 13-month lows, sterling could fall by up to another 10 percent in the coming months should Britain crash out of the European Union without a deal on future trade ties, luring more speculators to bet against the currency.
Sterling lost almost two percent last week just as British holidaymakers weren’t heading off for some overseas sun .
The latest move lower was kick started by trade minister Liam Fox’s warning that, with Britain less than eight months from its scheduled EU departure date in March, there was a 60 percent chance of leaving without a deal.
The moves were certainly exacerbated by a big and broad dollar rally, and the pound has since clawed back the worst of its losses against the euro, rebounding from 10-month lows
But the worry, say analysts, is that in the absence of any conclusive developments towards a deal over the coming months, the pound’s spiral will accelerate while the clock ticks down on the deadline and hedge funds are tempted into betting against the currency.
How will sterling trade in the later stages, then?
Most economists still believe Britain will reach a deal with the EU. But the latest Reuters polls indicate risk of no deal have risen to 25 percent, versus 20 percent in July.
Some bookmakers price even higher odds, above 40 percent.
If that comes to pass, Britain’s currency would crash to $1.20 – from today’s $1.2750 levels, the Reuters poll showed, a fall of around 6 percent. But sterling is forecast to rise to $1.34 by end-January if an agreement is reached.
Others predict more precipitous falls – Commerzbank sees a 10 percent drop against the dollar and euro. That would leave the pound close to parity with the single currency, below post-Brexit referendum lows of 94 pence and current levels of 89.2 pence.
The uncertain outlook and the prospect of a sudden sterling surge had kept many hedge funds on the sidelines. Now though, sensing profits to be made, some funds have begun to wager against the pound. Prominent Brexit campaigner and hedge fund boss Crispin Odey told Reuters he was betting against sterling.
He predicts it will hit $1.21 before March.
Concern may be mounting at the corporate level too. A senior currencies trader at a large European bank said British exporters had rushed to hedge themselves, while speculators were using options to short the pound in increasing numbers.
“Below the $1.30 mark is where corporates start to get nervous,” the trader said, speaking on the condition of anonymity. “Hedge funds have been buyers of sterling on the dips but that’s starting to change. If it weakens further, we will see some accelerated selling.”
Perhaps reflecting that shift, the price investors are prepared to pay for the future right to sell sterling has rocketed.
Demand for options to sell sterling climbs to highest since Jan 2017
Three-month sterling/dollar risk reversals, a gauge of put-to-call options, have plunged to their weakest level since January 2017, indicating heightened demand for ‘puts’ — derivatives that give holders the right to sell an asset.
‘Call’ options give the right to buy.
As Brexit approaches, more wild price swings are likely.
Sterling/dollar three-month and six-month implied volatility gauges , which measure price swing expectations, have shot to their highest since February. Nine-month implied volatility, which covers the official March 29, 2019 Brexit date, has spiked even further, to 17-month highs.
Even relatively stable euro/sterling three-month implied volatility is at its highest since March.
Pound volatility gauges spike to highest since February.
Yet shorting sterling remains a risky play.
“Sure, there is gloom now but the currency remains undervalued as it has been historically,” said Geoffrey Yu, Head of UK Investment Office at UBS Wealth Management. “Some [buyers] will see this as an opportunity.”