All about sterling as market scrambles to price Hard Brexit risks
GBP is collapsing and if we are really headed toward a hard Brexit, there is more downside potential to price in.
The sterling price action has gotten downright brutal as market participants scramble to position for Hard Brexit risks on the latest exchange between the UK and the EU. The latter issued a three-week ultimatum for the UK to back away from its drawing up of plans to override portions of the withdrawal agreement and threatened legal action. The UK shrugged off this push from the EU and neither side produced any language that was remotely hopeful. GBPUSD six-month implied volatility for options has risen close to 11.5%. Besides the chaotic high in March during the COVID-19 panic, this compares with highs around 12.0% during the hard Brexit fears about a year ago before the withdrawal agreement was drawn up and almost 14% in the late 2018 stand-off. The situation is as serious as it has ever been because this time we are finally talking about the actual reality on the ground for the UK post-Brexit that will prevail in less than four months. Will realpolitik prevail and the two sides hammer out an amicable agreement, or is this a fight on principles that means both sides are willing to suffer significant damage to defend their principles: the UK on its sovereignty and the EU on ensuring the UK doesn’t enjoy advantages not available to its own members? I fear the latter.
EURGBP has ripped to a new post-COVID-19 panic high after yesterday’s developments and we could see further repricing of GBP to the downside as long as the stand-off persists. Both sides will take a hit in the event of a truly hard Brexit, with the economic hit to the UK far harder and requiring a far greater mobilization of fiscal and monetary stimulus to offset for the damage – which would bring with it fears of more deeply negative real rates in the UK, akin to the fears that have driven the USD lower. For now, one eye on headlines and the other on the 0.9150-75 pivot area broken in EURGBP on the way up and then on the COVID-19 panic highs into 0.9500+. Let’s recall that the reaction to the Brexit vote back in 2016 only took EURGBP as high as 0.9415.