Morning Brief – Swan Song

Swan Song

With only two days to go until the European Summit, volatility is rising across GBP, EUR and even USD currency pairs as the financial world braces for the race to secure the European Recovery Fund and, in its fifth consecutive year of consideration, Brexit. In options markets, the implied volatility within cable (GBPUSD) and the Sterling-Euro currency pairs has risen to levels paralleled only by the height of the first wave of the pandemic in late March. One-week implied volatility in the Pound stands at 17.4% versus the Dollar and is comparable versus the Euro. Driving this implied volatility even higher is the underlying positioning within the Pound.

As of last week, of all open and reported positions we learned that open interest in the Pound Sterling within futures and options markets was -12%. That represented tens of billions of Pounds worth of contracts that were betting/insuring against the Pound falling. The last positioning data released yesterday showed that open interest is now just -5%, demonstrating that a lot of buying must have taken place over the past week to cover the short positioning. This goes some way to explain the rally in GBP over the past week and, crucially for the outlook of the Pound, leaves considerably more room to fall, and still substantial headroom to rise, should the political and economic outcomes become more definitive.

Given the so-called short covering in GBP, the Pound now has a long way to fall lower should a no-deal be delivered as the outcome of Brexit. The record for short positioning in GBP this year is around 25%, leaving a huge gap beneath Sterling for selling interest to be accrued should the outlook for a trade deal deteriorate. At just -5% of open interest, there is still some room for investors to turn bullish on the Pound if success in the negotiations became apparent. So, what will happen, and will we get a deal?

The EU have extended a somewhat limp looking deadline of tomorrow to secure agreement and accord on a trade deal to allow for ratification in national and EU parliaments. This is to allow room for the EU Council Summit on Thursday and Friday of this week to potentially sign off on a deal for parliamentary scrutiny. But this is no normal EU summit and if tomorrow’s deadline comes and goes without agreement, could provide the political momentum to generate concessions that would allow agreement between negotiators. This summit is special because it is (probably) Germany’s final summit before the rotating presidency of the European commission is lost and passed onto other members. It is therefore Germany’s last change to effect real change and wield true power over the EU27 to get Brexit and secure the European Recovery Fund. Germany will therefore be itching to get something done to make a success of its otherwise troubled and unsuccessful presidency.

This period too is Chancellor, and EU Council member, Merkel’s swansong era. With the German election in September next year, we know that she will not be running once again following more than 15 years in power. It is not only Germany’s last change to facilitate change and build a legacy of success as President of the EU Council but also it is Mrs. Merkel’s final few opportunities to cement her legacy on the national and European stage. Typically cautious and meticulous in politics romantics could dream therefore that sentiment and preparations for nostalgia could come into play for Germany’s premier and push a deal on both factors over the line.

Discussion and Analysis by Charles Porter

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