Pound Investors Have Too Much on Plate to Obsess About Brexit

(Bloomberg) -- Even with the risk of a hard Brexit hanging over their heads, pound traders seem to be looking the other way.

The currency touched a three-week high against a weaker dollar, one day before fraught trade negotiations resume between London and Brussels. A gauge of sentiment in sterling over the next month, which covers the deadline for an extension to the U.K.'s Brexit transition period, is the least negative since late March.

It's a sign Brexit has lost some of its power to rattle investors, as concerns shift to the economic impact of the coronavirus pandemic and the possibility of a second wave of outbreaks after the U.K.'s lockdown eases.

“It has been a little surprising, frankly, that the foreign-exchange market has been as willing as it has to give sterling a pass this time around,” said Ned Rumpeltin, European head of foreign-exchange strategy at Toronto-Dominion Bank. “The virus and its aftermath remains the main focus for markets.”

The pound rose as much as 0.7% to $1.2426 on Monday, the highest since May 11. It snapped a three-day losing streak against the euro, advancing the most in nearly a week.

Few analysts expect a political breakthrough this week. There could be damaging headlines for the process in coming days after the bloc's chief negotiator Michel Barnier told the Sunday Times the U.K. needs to be “more realistic” in its demands.

Still, there's been no spike in the cost of insuring against a swing in the pound against the dollar in options. For the next month, it's hovering near the lowest level since early May.

That contrasts with the roller-coaster ride suffered by the pound throughout 2019 on fears of a no-deal exit and turmoil in Parliament. These have been swept away by more immediate concerns about shuttered factories and consumers stuck at home. The influence of politics is diminishing, while focus intensifies on the risk of large-scale unemployment and emergency changes to fiscal and monetary policy.

Eyes on BOE

Traders have stopped hanging on the words of lawmakers and are instead scrutinizing comments from Bank of England policy makers on the possibility of negative interest rates, which have weighed on the currency. It also narrowed the spread between 10-year gilt and bund yields to the smallest gap since since 2016.

Negative rates may become unavoidable especially if there is a no-deal Brexit at the end of the year, said Christian Schulz, director of European research at Citigroup Inc. Such a move by the BOE could lead the pound to revisit 35-year lows hit in March, according to Lee Hardman, a foreign-exchange strategist at MUFG.

Investors are betting the U.K. will join the negative-rates club by the end of February, according to overnight interest-rate swaps. Last month, the market saw such a move in November this year.

How Bad is Bad?

Against this backdrop, anything short of a Brexit disaster can look like good news. Pound traders may be betting that warm words between the two sides will send the currency on a short rally, even though a deal appears nowhere in sight. Yet reality could soon start to sink in if Britain and the EU harden their positions.

“The U.K. Brexit premium is elevated,” said Jordan Rochester, a currency analyst at Nomura International Plc. “It's just not as bad as it was with past hard-Brexit fears in 2018 and 2019.”

Sterling volatility is likely to accelerate into the summit of EU leaders on June 18 and 19 June, according to Jeremy Stretch, head of G-10 currency research at Canadian Imperial Bank of Commerce in London.

“I am not sure there is any overt optimism as regards the Brexit talks,” he said. “Should no-deal risks extend, expect sterling to prove an under performer.”

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