British Pound Clings on to Gains in Face of Impasse Over Brexit Talks

LAGOS (Capital Markets in Africa) – Pound traders are holding on to Brexit optimism as talks toward a Brexit deal remain stuck over the contentious Irish border.

Sterling touched a five-month high Wednesday after surging the most since 2008 in the past four days as an end to the Brexit saga appeared to be in sight. The currency swung between losses and gains as the Democratic Unionist Party denied reports it may support some of the latest proposals, an issue that has risked collapsing this week’s talks.

Still, for currency traders there seems to be a silver lining with the intensity of the negotiations spurring confidence there is the political will on both sides to avoid a no-deal Brexit. U.K. Brexit Secretary Stephen Barclay told a parliamentary committee Wednesday that Prime Minister Boris Johnson will seek an extension on Saturday if a deal hasn’t been reached by then.

“Sterling performance remains binary and reflects the tone of the negotiations,” said Jeremy Stretch, head of Group-of-10 currency strategy at Canadian Imperial Bank of Commerce. “Rumors of DUP resistance take sterling lower, hopes for a resolution in Brussels take it higher. It feels like the market is increasingly confident a deal will be done, or perhaps more accurately it’s more confident of no-deal being avoided, encouraging paring of pound shorts.”

The currency market hasn’t been this twitchy over Brexit since the aftermath of the referendum that set off the process in 2016. The past few days have seen conflicting Brexit headlines forcing traders to reposition for a swift and brutal move once clarity emerges.

The pound steadied at $1.2784 by 1:40 p.m. in London, whipsawing between a drop of 1% and a five-month high of $1.2840. U.K. government bonds erased most of their gains, with 10-year yields down one basis point to 0.68%, while the U.K.’s domestic-focused FTSE 250 stock index fell 0.3%.

Short Covering
Some of the apparent pound optimism could come down to investor positioning, according to Nomura International Plc strategist Jordan Rochester. The market was overwhelmingly in favor of selling sterling and asset managers and hedge funds still hold short positions overall, according to the latest data from the Commodity Futures Trading Commission.

“I have been impressed how the market has been taking every negative headline as an opportunity to buy back the pound here, a sign perhaps that despite the move, positioning is still long euro-sterling,” said Rochester. “The pound is failing to truly break lower on this bad news.”

The euro only gained 0.1% against the pound to 86.35 pence, after rallying as much as 1%. Hedge funds were seen selling the euro at around 87 pence, according to traders in Europe, who asked not to be named as they were not authorized to comment.

Time is running out to secure a Brexit deal before this week’s summit of European leaders, as Johnson struggles to win the support of the DUP. EU officials are also concerned the revised plan leaves open the possibility that Britain could undercut the bloc in certain areas.

Option traders are pricing high levels of volatility over the coming week. One-week implied volatility in the pound-dollar pair surged to 20.07%, the highest since July 7, 2016.

Morgan Stanley sees a 65% chance of a Brexit deal, up from 55% last week. However, the bank expects Parliament to reject it, which it sees leading to a further extension and elections to decide the way forward on Brexit. The pound would likely drift higher toward $1.30 in this scenario, the bank said.

Source: Bloomberg Business News