Morning Brief – Rough in the Diamond

Rough in the Diamond

The day of Johnson and Corbyn’s reckoning is upon us. As the polls opened at 7AM this morning Sterling sat atop an 8-month high against the US Dollar having gained almost 1% in the final week of the general election campaign. However, as voters head to the polls today, the market prices an implied one-week volatility in excess of 18% in cable (GBPUSD). To put this risk in perspective, you should note that it is considerably higher than the present implied volatility of Silver, an asset that moved by more than 28% in three months this year against the US Dollar. Conclusion: whatever the result of the general election, expect some meaningful moves in the international value of the Pounds in your pocket. You GBPEUR traders out there will note that implied volatility in this pair is lower given that Brexit affairs impact both the United Kingdom and the Union that it is seceding from. 

Over the course of the last week investors have continued to add to their holdings of downside protection contracts despite a rally in Sterling’s spot valuation. Both GBPEUR and GBPUSD derivative markets offer downside protection at a greater cost than upside appreciation to a degree not seen in the past 8 months. A strong Conservative majority will therefore equilibrate this imbalance squeezing further value from the Pound. Look for appreciations of approximately 2% to the upside upon confirmation or indication of a decisive majority. If the fate of UK politics is for another hung parliament and coalition, expectations of political uncertainty and risk will see the Pound lose value. 

Headway for GBPUSD has already been created by the Federal Reserve interest rate decision yesterday with the Dollar weakening by around 0.5% on a trade weighted basis. The reason for the greenback’s sell off is an adjustment in FOMC Chairman Jay Powell’s framing of 2019’s three rate cuts from a temporary adjustment to the new norm. Markets had been pricing a rate hike for 2020 that was not confirmed by the Fed’s dot plot yesterday. However, pricing in the expectation of a 1.5-1.75% policy rate band for longer, the expected yield and reward that the Dollar will afford was slashed, curtailing the market’s demand for the asset. 

The rough of uncertainty in the pound and global markets in general is leading to defensive haven demand and constructive positioning to the demise of the other 8 G-10 and emerging market currencies. A ray of sunlight in the form of political progress and evidence of the trade war thawing by a delay to the imposition of tariffs ahead of Monday’s market open and markets will look more fondly upon risk assets once again. 

Discussion and Analysis by Charles Porter

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