Investment Clock insights

Sterling volatility spikes on Brexit uncertainty


Trevor Greetham

12 November 2018

Heightened Brexit uncertainty has pushed the cost of hedging portfolios against a drop in the pound to its highest level in almost two years (chart 1). Time is running out with the UK due to leave the EU in March 2019 but all options are still plausible, from a chaotic No Deal exit, through leaving the EU under the Chequers Deal to remaining in the EU on current terms after a referendum on the final deal. Political risk is high and rising so it’s not surprising investors don’t know which way to jump. 
Currency markets don’t like uncertainty. We are modestly underweight sterling in the Royal London Global Multi Asset Portfolios and have deepened that position as volatility y has risen. We are likely to add back to the pound when volatility calms down once more.
Brexit could go either way and the outcome will be very hard to call. Investors with a low risk appetite may want to invest primarily in sterling-denominated assets so they don’t have to worry too much about changes in the exchange rate. Investors with a higher risk appetite could hedge their bets to some extent by balancing domestic and overseas equities, which we feel could do better in a more disruptive scenario in which the pound declines, with commercial property, an asset class we would expect to do better in a closer relationship with the EU.

Heightened Brexit uncertainty has pushed the cost of hedging portfolios against a drop in the pound to its highest level in almost two years (chart 1). Time is running out with the UK due to leave the EU in March 2019 but all options are still plausible, from a chaotic No Deal exit, through leaving the EU under the Chequers Deal to remaining in the EU on current terms after a referendum on the final deal. Political risk is high and rising so it’s not surprising investors don’t know which way to jump. 

Currency markets don’t like uncertainty. We are modestly underweight sterling in the Royal London Global Multi Asset Portfolios and have deepened that position as volatility y has risen. We are likely to add back to the pound when volatility calms down once more.

Brexit could go either way and the outcome will be very hard to call. Investors with a low risk appetite may want to invest primarily in sterling-denominated assets so they don’t have to worry too much about changes in the exchange rate. Investors with a higher risk appetite could hedge their bets to some extent by balancing domestic and overseas equities, which we feel could do better in a more disruptive scenario in which the pound declines, with commercial property, an asset class we would expect to do better in a closer relationship with the EU.

Chart 1: Cost of hedging sterling risk as measured by the 1 month implied volatility of the sterling/dollar exchange rate

Source: Bloomberg as at 12 November 2018

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