The pound soared and U.K. bonds fell on mounting optimism that Britain and the European Union are finally closing in on a Brexit trade agreement.
Sterling advanced by as much as 1.6% to $1.3571, the biggest intraday gain in more than a week, following a report that negotiators are increasingly hopeful an accord could be struck as soon as Wednesday. The yield on 10-year government bonds was poised for the biggest rise since March, climbing 11 basis points to 0.30%.
“The tea leaves are shaped in the right direction,” said Luke Hickmore, a fund manager at Aberdeen Standard Investments who helps manage 35 billion pounds ($47 billion). “Certainly the market is buying into it.”
Options traders were also positioning for a deal, dragging down the cost of hedging a weaker sterling over the coming month to the lowest since Dec. 4.
Still, investors have become hardened to expectations for a deal being raised and dashed, and there were notes of caution even if a breakthrough is imminent.
“Markets are back to buy-the-rumor mode,” said Simon Harvey, a foreign-exchange analyst at Monex Europe. “Due to the limited nature of a deal, we don’t necessarily see sterling finding too much relief beyond an additional percentage point,” especially as tighter restrictions look to be extended to other parts of the U.K., he said.
Christmas Volatility
The pound’s reaction to a decision over post-Brexit trade will probably be more volatile now with currency-market liquidity dwindling ahead of Christmas.
Negotiators from the two sides are in the very final phases of the talks, officials said. Discussions are still continuing on fisheries, the biggest obstacle to an accord. If the two sides can’t reach a deal by Dec. 31 Britain could crash out of the European trading block, disrupting decades of free movement for people, goods, services and capital.
If there’s a trade agreement, “there will be more demand for the pound than the market can absorb in such a thin market, so we’ll see spikes but it will level off,” said Bob Stoutjesdijk, a Rotterdam-based fund manager at Robeco Institutional Asset Management. He sees the pound surging as much as 3% on a deal before ending the day up 2%, and tumbling up to 4% if talks collapse.
The pound is already trading in turbulent territory as the time for a deal runs out. Volatility over the past week is near the highest since March, when the coronavirus roiled global financial markets. At about 15%, it’s nearly double that of the euro-dollar pair. And its implied volatility over the next week beats all other currencies, save Brazil’s real and Turkey’s lira.
The seasonal pattern adds fresh drama for traders already grappling with a year-end deadline for reaching a trade deal and the economic fallout from the coronavirus pandemic.
BlueBay Asset Management LLP’s Chief Investment Officer Mark Dowding, who oversees $70 billion, says it’s hard to quantify how much thin liquidity will amplify the pound’s moves as Brexit news develops. He recently offloaded bullish bets on the currency on the escalating risk that the U.K. will crash out of the trading bloc.
“If talks fail at the last minute, the reaction of the pound will hinge on whether discussions are ongoing, or whether there are recriminations and acrimony,” he said. The former scenario could see the euro-sterling pair test the 0.9400 level. And the latter could send the pair hurtling toward parity for the first time, he said.
