Investors’ jitters over the Brexit referendum have reached levels not seen since the 2015 general election as financial institutions seek protection from a fall in sterling, according to market data.
Measures of volatility in the value of sterling indicate mounting fears that Britons may vote to leave the EU and further weaken the British pound.
Since the end of 2015, more people have been looking at ways to sell sterling-denominated assets over the next six to 12 months – by taking out contracts that allow them to dump the pound if it drops below a certain level – than those looking to buy the currency. This has been highlighted in data for one year 25 delta GBP-USD risk reversals, which compares the number of people who wish to buy or sell sterling at a certain date. In early January this traded at -2.5%, with the negative reading showing that more people are looking to sell sterling than want to buy. This is close to the pre-general election nadir of -2.7% and has already surpassed the pre-Scottish referendum level of -2.1%.
The negative values indicate that “puts”, which give option holders the right to sell to a counterparty a specific amount of a currency within a specified timeframe, are more expensive than “calls”, which mean option holders have the right to buy currency from a counterparty. It means that protection against a slide in the value of sterling is more costly than taking protection against an increase in the pound.
Recent polls point to a tight contest in the referendum, with several online surveys placing the vote to leave camp marginally ahead. To add to the unpredictability, the vote to stay remains substantially ahead in phone polling.
The main factor of uncertainty worrying investors still remains the lack of clarity over when the referendum will be held. One year-rate of implied volatility in GBP-USD – a measure of risk related to sterling – has been capped at around 10.6 recently. This is the same level as its pre-general election high, when most expected a hung parliament and months of constitutional confusion.
A greater implied volatility indicates the higher potential instability of an exchange rate over time. The same measure traded to 8.0 ahead of the Scottish referendum in 2014.
Also, an increase in demand for contracts that protect financial institutions against a volatile pound between June and December suggests that the market is positioning itself for the referendum to take place between June and November 2016. It suggests that the market expects sterling to be volatile around these dates.
The data is likely to be influenced by worries surrounding the global economy, a weakening pound and delays in any Bank of England decision to hike interest rates. However, the implied volatility and risk reversals into the first six months of the year hint that the timing and potential outcome of the EU referendum is a key driver.
Eimear Daly, an FX strategist at Standard Chartered bank, said that “an acceleration of developments surrounding the EU referendum and increased news coverage has brought the UK’s EU referendum into the market’s focus. GBP is no longer trading largely on expectations for when the Bank of England will raise interest rates. The complete uncertainty over the EU referendum is one reason behind the GBP’s recent slide. GBP will likely only be able to recover its losses on a ‘stay’ referendum outcome.”
There is growing optimism that Cameron will secure a deal in February, paving the way for a referendum in June. Last week, Jean-Claude Juncker, the European commission president, said he was quite sure that “a permanent solution” would be reached next month.
