Vodafone Group and the Impact on Pound / US Dollar Exchange Rate (VOD GBP)

By Gary Howes

Barclays warn that those forecasting a strong rise in the pound dollar exchange rate (GBP/USD) on Friday due to Vodafone Group (VOD) M/A flows could be overly optimistic.

UPDATED (See last para). Friday has already seen some interesting price action in the pound sterling / US dollar exchange rate (GBP/USD) with a spike in the rate being seen despite all economic data at 09:30 coming in below par.

The British pound sold off immediately, but then was picked up by investors - we thought perhaps this demand could be attributed to traders taking immediate advantage of the drop to finance currency requirements surrounding the Vodafone Group corporate action due today.

Indeed, "part of GBP’s recent outperformance has been driven by anticipations of large cross-border flows resulting from the agreed Vodafone-Verizon deal," confirms Chris Walker at Barclays.

However, Walker has today issued his forecasts on the likely reaction of sterling, and for bulls this does not make for good reading.

A note to clients today says:

"When analysing the true effects of cross-border M&A flows, it is important to control for other factors that affect movements of FX and the incentives for cross-border investment. We control for these factors using our Financial Fair Value (FFV) model to examine previous periods of large US-to-UK transactions and find that M&A deals have generally had little lasting positive effect on GBP/USD beyond the initial week of an announcement.

"Indeed, there is some evidence that GBP/USD underperforms relative to fundamental drivers thereafter.

"There also appears little relationship between the size of a cross-border deal and FX performance (though the size and modalities of this specific deal may be different).

"However, GBP/USD has been consistently higher than the FFV implied value since September 2013 (when the deal was announced)."

Barclays believe expected deal flow has also been partly priced into option markets, in terms of skew and the level of implied volatility.

The expected deal flow has also been partly priced into option markets, in terms of skew and the level of implied volatility. We therefore see a good risk-reward in positioning for GBP/USD downside towards our 1m forecast of 1.64, with downside risks, given the possibilities for inflation and expectations for monetary policy. In light of these risks, we recommend buying a 6-week 1.6729 strike GBP put/USD call for 1.11% (spot ref 1.6680). We also take profits on our short EUR/GBP recommendation (initiated 9/12/13, spot ref; 0.8219) of 1.73%.