Pound vigilantes may not have enough ammunition to force parliament to pass Prime Minister Theresa May’s Brexit deal even in a second vote, influential investors say.
Speculation has been growing that sterling will plummet if parliament were to reject the divorce pact on December 11. This, the theory goes, would heap pressure on lawmakers to look for a way out, ensuring the deal is cleared eventually.
While the pound may fall on an initial rejection, the scale of drop will be nothing like the 8% plunge on the day the UK voted to leave the EU, according to M&G Investments and Pictet Asset Management SA that between them oversee almost $800bn.
Among those who see May succeeding in a second vote, an oft-cited parallel is that of US lawmakers agreeing to release funds for the Troubled Asset Relief Programme in 2008 after an initial rebuff roiled markets.
However, the UK situation is different, not least because the pound is historically cheap. Further, a ‘no’ vote by parliament would open the door to a multitude of possible outcomes, each pulling sterling in different directions.
“The pound is now one of the cheapest currencies on fundamental valuations, so that limits to some extent how bad things can get,” said Jim Leaviss, head of retail fixed interest at M&G. “It’s not the same place as it was going into the referendum.”
Option signal: Sterling was headed for its third week of declines on Friday, dropping to $1.2755, not far from the $1.2622 one-year low reached in August. The currency is undervalued by 26%, according to the BigMac index.
In the option market, traders are already banking on May’s deal failing to get the 320 votes required to pass on December 11. The premium to buy one-month put options on the pound relative to calls, a trade positioned for a large downswing, is still near this year’s highest levels.
BlueBay Asset Management LLP is among investors holding put options on sterling, bracing for a pickup in volatility, while keeping a short position on the currency. Despite the bearishness in the market, traders may still be too “complacent” about the risks, according to Mark Bathgate, a money manager at the firm.
‘Hard Brexit’: “There’s the risk of hard Brexit, and there’s the risk of ‘remain’ via a second referendum with all of this coming to a head in the next two to three weeks,” he said. “Most in the markets expect May’s deal to get through.”
Bank of England governor Mark Carney warned this week that sterling could drop 25% in a “disorderly” Brexit scenario – based on the UK leaving the European union without a deal – bringing it to below parity with the dollar. That course of events is still not the institution’s assumption though.
M&G Investments money manager Andrew Cole’s sterling-denominated fund is still 80% exposed to the currency, betting that the pound would fall significantly only if May is over 70 lawmakers short of a majority to pass her deal. The risk that the pound rallies in the days following the vote instead poses considerable risk for his portfolio.
“Don’t be too short and be wary of having too much overseas currency exposure because in the environment that the pound goes up, you lose money,” he said. “Is there a big enough trade there? Not for us.”
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