Cost of Protecting against Pound-Dollar Rate Slump Shoots Up
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- GBP/USD spot rate at time of writing: 1.3268
- Bank transfer rate (indicative guide): 1.2900-1.2996
- FX specialist providers (indicative guide): 1.3100-1.3175
- More information on FX specialist rates here
Data from Reuters shows the cost of insuring against a sizeable fall in the value of Pound Sterling over coming days and weeks has shot higher, a development that comes in sympathy with growing anxieties for a 'no deal' outcome to trade negotiations.
According to Richard Pace, a Reuters foreign exchange and options market analyst, the cost to protect against the Pound falling versus rising has gained in recent weeks and now trades at highs last seen after 2016's Brexit referendum.
One-month expiry GBP/USD 25 delta risk reversals are up from 0.7 GBP puts over calls in mid November, to 3.0 now.
"It shows a much greater perceived risk of GBP falling, than gaining," says Pace. "Implied volatility gauges future actual volatility over a given time, and that's higher, too. Combined with the high GBP put premium on risk reversals, it reflects a situation where implied volatility would increase further, should GBP fall."
The Pound-to-Dollar exchange rate has fallen notably at the start of the new week on heightened nerves that the EU and UK would be unable to achieve a post-Brexit trade agreement. The exchange rate has fallen to 1.3231, having been as high as 1.35 on Friday.
Above: The GBP/USD dropped sharply on Monday as fears of a breakdown in trade negotiations rose.
Corporates and investors often attempt to protect the value of their investments against fluctuations in currency markets. Buying exchange rate options can offer a away of protecting against big moves in that exchange rate in the future. But, the more a particular option is in demand, the more expensive it has become.
Therefore, if the cost of buying options that protect against a fall in the value of Sterling is growing, it suggests the market is becoming increasingly nervous of a big downside move in the value of the currency.
"Sterling risks to Brexit no-deal endgames were exposed this morning as the chatter was less optimistic than many of us thought it would be, with reports in one paper indicating Boris Johnson is ready to walk away within hours. Moreover, confusion over progress on fishing has clearly unnerved the market. GBPUSD slipped from 1.34 overnight to 1.3280 in early trade, a chunky move to start the session and reflective of both the pound’s sensitivity to headlines and the severe downside risks from a no-deal Brexit," says Neil Wilson, Chief Market Analyst at Markets.com.
The British Pound fell at the start of the London trading session as traders priced in the prospect of a 'no deal' outcome to EU-UK trade negotiations after a UK newspaper reported Prime Minister Boris Johnson was ready to quit talks within hours.
The Sun reported Monday morning that Johnson was ready to walk away from negotiations "within hours" as demands being made by the EU were "outrageous".
"It really is end game stuff now. If by close of play Monday there is no movement there'll at least be a question about whether it is worth carrying on. We're not going to give into EU demands preventing us taking back control of the rules Britons live under. It's that simple".
Volatility in the UK currency is likely to be elevated this week with traders and automated trading algorithms likely to be reactive to rumours, briefings and official updates on the status of post-Brexit trade talks which could yield either a positive breakthrough or end in failure on Monday.
Media reports say EU Chief Negotiator Michel Barnier has already confirmed to EU ambassadors that the three outstanding topics of fisheries, level playing field rules and governance remain unresolved. Media are reporting that Barnier was downbeat on the prospects of a deal being achieved.
UK Prime Minister Boris Johnson is expected to call EU President Ursula von der Leyen tonight to try and achieve a political solution to those issues negotiators are unable to agree on during today's talks.
A successful outcome to the von der Leyen-Johnson call would likely allow negotiators to keep talking into Tuesday and Wednesday, either of which days could yield a breakthrough.
Talks could therefore run into Thursday and Friday's European Council meeting, where EU leaders could agree amongst themselves a final offer to make the UK.