FxWirePro: Mounting Hedging Sentiments for Bearish Sterling on “No Deal Brexit” as underlying GBP pairs head for fresh 1y lows

Sterling continued its bearish streaks owing to the driving forces of augmented apprehensions about the UK leaving the EU without an agreement (“no deal Brexit”). 

In this context, the argument that a feeble currency would back-up the export sector and thus the economy. However, the hitch is that this positive effect on trade flows takes some time to come into force. The depreciation is going to make imports more expensive, as the UK’s dependence on food imports from the EU is likely to rise. 

As a result, GBP remains under pressure across the board, as the market increasingly ‘prices’ a higher chance of a ‘no deal’ Brexit. Almost all the major GBP pairs are heading for 1-year lows. The key levels to monitor are: 1.2850 (and then 1.2780-1.2600) in GBPUSD, 0.9040 (and then 0.9160-0.9300) in EURGBP and 141.70 (and then 141.20-139.20) in GBPJPY.

This is reflected above all in the options market where hedging against a collapse of Sterling has become much more expensive (refer 1stchart for EURGBP risk reversals) – with the prices still being a long way off the 2016 highs though. 

However, what is worrying about yesterday’s move is the fact that there was no obvious trigger for it, which to my mind constitutes a warning sign that the Sterling weakness might develop self-reinforcing tendencies. In such a case, an acceleration of the downtrend would have to be expected, exactly the worst-case scenario for Sterling that we have been warning about since the Brexit referendum. 

After all, for the individual investor it is no longer decisive at this juncture whether they themselves still believe in an amicable agreement between London and Brussels but what they think all others expect - at least if they want to avoid being the last ones to square their GBP investments (at even lower prices at that point). The fact that Great Britain records high current account deficits (see 2ndchart) and therefore requires constant capital imports to finance these, clearly makes the situation worse. 

In case of the capital flows drying up or even a capital flight the current account would have to be adjusted which would of course be more painful for the economy the higher the capital requirements are. The result would be a deep economic crisis.

All these bearish driving forces seem to be factored-in OTC markets. Please be noted that the positively skewed IVs of 2m tenors signify the bearish hedging interests to bid OTM put strikes upto 124 levels (refer above nutshell evidencing IV skews). 

As you could observe the above-nutshell evidencing risk reversals of sterling (GBPUSD and EURGBP) is signalling extreme bearish risks across all tenors, bearish risks remain intact even in the long-run (refer risk reversal table).

Currency Strength Index: FxWirePro's hourly GBP spot index is inching towards -50 levels (which is bearish), while hourly USD spot index was at -8 (absolutely neutral) and EUR is at 74 (bullish), while articulating (at 10:35 GMT). For more details on the index, please refer below weblink:

http://www.fxwirepro.com/currencyindex