Morning Brief – The bigger they are, the harder they fall

The bigger they are, the harder they fall

9/10. Today’s Britishism above isn’t half bad. Whether subject to a physical, empirical examination of the pure mass of an object and the Newtonian force with which it falls or a more normative evaluation of how a highly regarded truth or person loses their status, it usually seems to check out. Lastly, not being one of the English language’s endless impenetrable idioms is a bonus. It only misses out on achieving the final decile because sometimes the larger something is, the greater relative protection it has against a hard fall – Prince Andrew? 

But FX markets can offer an exhibition into the phenomenon of size-relative fall out. When large currencies move, not only due to the volumes that they are traded in each day and the sheer size of commerce beneath that price level but rather due to their reputation and integration in the entire system, they tend to create global ripples. A US Dollar move for example experiences a relatively larger fall because its decline supports currencies including the Loonie and Aussie due to the Dollar’s status as the global unit of exchange. 

Of pertinence this morning as we awake with the general election in the UK only one week away is how GBP will handle a fall should it experience deteriorating sentiment and an indecisive election result. Yesterday saw an immense rally in Sterling. The Pound gained and retained an entire cent against the US Dollar as markets reacted to largely unchanged polling results and an as-then-incomplete NATO experience that hadn’t been a complete disaster for Johnson’s campaign. But looking beneath the surface we see markets changing their positioning for next week’s election. 

One week implied volatility has ratcheted up by almost 1% and investors have added to their net-short bias against the Pound. In other words as they’ve been buying up the Pound yesterday, they’ve also been betting against its future value. Strange?! Not entirely – as investors face higher prices due to positive market sentiment but still perceive volatility they might want to protect that profit and price move from downside movement – buying now and simultaneously buying the right to sell at this level later. 

The market action yesterday serves to show us that the Pound is braced for a rocky week or so as we learn the composition of its political leadership that will guide it through the next Brexit deadline. Given the extension of net short positioning, a decisive election result that delivers a strong Conservative majority will provide even more evidence of a short squeeze and position adjustment. In this case, the bigger they are the harder they rise. However, with implied volatility rising in Sterling based crosses and exhibiting the highest anticipated movements in the G-10 space, a rise or fall in the Pound after next Thursday’s election is certain to cause a splash. 

Discussion and Analysis by Charles Porter

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