Positioning for sterling volatility

23 May 2019

Since the Brexit referendum in June 2016, it would be fair to say that sterling has experienced, as many expected, a troublesome time.

In the four months following the vote, sterling dropped by over 15% to a monthly average of $1.2183 against the US dollar in October 2016 versus $1.4358 in the decisive month. On the day after the vote alone, sterling had actually dropped just under 8% when compared against the dollar (1.3626 v 1.4807).

This hardly seems surprising given the unprecedented political and economic landscape the UK was and is still, facing. The Bank of England was quick to cut rates from 0.75% to 0.25% and withstood a considerable inflation overshoot, stemming from the significant depreciation in sterling.

Turbulent ride

What is more interesting however is the turbulent ride that the pound experienced since October 2016, including its rise up to early 2018 to close to pre-Brexit levels. This included a period consisting of a general election under which May only just managed to stay in power, with the caveat that she needed a coalition with the Democratic Unionist Party. Partially explaining this move was the Bank of England hiking rates in November 2017 to 0.5% as a result of surprising economic resilience and the aforementioned inflation overshoot.

Such a recovery in our view always appeared unsustainable with Prime Minister May continuously battling her own cabinet, her own party, the opposition parties and the European Commission.

It did not take long for markets to realise this. What followed was a downward trajectory where May managed to agree a deal with the EU but get it rejected three times in her own parliament. Any other suggestions from MPs (be it binding or non-binding) also failed to get a majority in the house.

Whilst not at its October 2016 levels, the pound is now below $1.27 and as of 23 May, had been beaten by the euro over the last thirteen sessions. Putting this into context, this is the worst run since the euro’s inception.

Downward but volatile history graph

Outlook for sterling

As investors are growing frustratingly used to, twists and turns are inevitable in the Brexit backdrop. Theresa May added to this on Tuesday with the inclusion of a vote on a second referendum (sterling rallied when this happened), only to come back down when it was realized said vote would only occur should her bill pass.

Consequently, the spectrum of outcomes remains as wide as possible, ranging from no Brexit to no deal. The latter is a lot more likely should May depart from office without securing a deal, as the chances of her being replaced by a Eurosceptic candidate increase.

Furthermore, getting a deal through parliament is the “easy” part. There is likely to be two years of transition fleshing out the exact nature of the trading relationship between the eurozone and the UK.

In light of these factors, a sustained period of increased volatility in sterling seems plausible.

Implications for investors

At a time of much uncertainty, taking a position on the UK currency either way is likely to place too much importance on getting the call right when uncertainty dominates the decision.

As a result, we feel it is best to be positioned in a way to withstand the volatility in sterling as opposed to taking a bet.

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