Menu

Search

Menu

Search

FxWirePro: EUR/GBP IVs least among G7 FX space, long-term hedging of Brexit and ECB risks appear to be cheaper

The Brexit negotiations about the transition phase from March 2019 to the end of 2020 are ongoing. The negotiating partners have set a tight deadline until the end of March. That deadline might lapse without result. The foreign exchange market is currently not pricing this risk adequately. To put it another way, it currently offers very low insurance premiums for potential future pound weakness.

As the ECB edges towards normalization, an undervalued euro has room to rise further, we could foresee bullish scenarios for euro, given that the ECB changes guidance today, heralding an end to QE in Sept and hikes by 1Q’19.

The currency market currently sees only minor risks for significant GBP weakness. It expresses this view in the risk reversals, the difference in insurance premiums against significant ups versus premiums against significant downs of EURGBP. The insurance against significant upward movements of the EURGBP (i.e. significant weakening of the Pound) is hardly higher than that against significant GBP strength (refer 1st chart).

This market view is not in line with our expectations about the further negotiation process. Currently the details of the transition period (from March 2019 to end-2020) are on the table. What should the relationship between the EU and the UK look like during this period? The negotiating partners have set themselves an ambitious schedule: They want to agree on this part of the Brexit deal by the end of March. However, a situation could easily arise in which at least one side plays for time. After all, an agreement does not really have to be finalized until October in order to make the necessary technical preparations for the transition. This means that both sides will be tempted to hold on to their negotiating positions for as long as possible and let the March deadline pass if necessary. Rumor has it that both sides are preparing for this scenario. We believe it is possible that, in this case, the Pound may experience a temporary episode of weakness. The market does not see it that way.

Hedging against such circumstance seems quite cheaper: Please be noted that ATM IVs of EURGBP across all tenors are the least among G7 FX space.

2M risk reversals are trading close to zero, and 2M ATM volatility in EURGBP is still trading at quite a low level (refer 2nd chart). Undeniably, if the expiry of the March deadline would be only the result of negotiating tactics, this does not imply that a timely agreement by October will fail.

However, the failure to meet the March deadline certainly does not make an agreement more likely. On the contrary, the “risk” increases with every expired deadline. And this should at least increase the insurance premium for GBP weakness in October.

This means: the low 6-month risk reversals (refer 1st chart) and the low 6-month ATM volatility in EURGBP (refer 2nd chart) could be a quickly disappearing opportunity, which the market might correct once the March deadline has expired. In other words, even for those who only want to protect themselves against an unsuccessful expiry of the (more important) October deadline, the foreign exchange market currently offers what we consider to be an unjustifiably cheap insurance policy. Courtesy: Commerzbank

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

http://www.fxwirepro.com/invest

  • ET PRO
  • Market Data

Market-moving news and views, 24 hours a day >

June 22 14:30 UTC Released

USECRI Weekly Annualized

Actual

3.1 %

Forecast

Previous

2.7 %

June 22 14:30 UTC Released

USECRI Weekly Index

Actual

150.1 %

Forecast

Previous

149.3 %

January 31 00:00 UTC 206973206973m

ARAnnual Primary Balance*

Actual

Forecast

2016 bln ARS

Previous

Bln AR bln ARS

January 31 00:00 UTC 206973206973m

ARAnnual Primary Balance*

Actual

Forecast

2016 bln ARS

Previous

Bln AR bln ARS

January 22 19:00 UTC 218793218793m

ARTrade Balance

Actual

Forecast

Previous

-1541 %

January 31 00:00 UTC 206973206973m

ARAnnual Primary Balance*

Actual

Forecast

2016 bln ARS

Previous

Bln AR bln ARS

January 22 19:00 UTC 218793218793m

ARTrade Balance

Actual

Forecast

Previous

-1541 %

January 31 00:00 UTC 206973206973m

ARAnnual Primary Balance*

Actual

Forecast

2016 bln ARS

Previous

Bln AR bln ARS

January 31 00:00 UTC 206973206973m

ARAnnual Primary Balance*

Actual

Forecast

2016 bln ARS

Previous

Bln AR bln ARS

January 31 00:00 UTC 206973206973m

ARAnnual Primary Balance*

Actual

Forecast

2016 bln ARS

Previous

Bln AR bln ARS

Close

Welcome to EconoTimes

Sign up for daily updates for the most important
stories unfolding in the global economy.