GBP/USD has stormed to the highest level of the year, taking the gains in the last five days close to 6% and has $1.5000 firmly in its sights. GBP/JPY has pushed up a lazy 900 pips in the same time, but yet if we look at GBP/USD risk reversals (these measure the skew of put optionality over calls) we can see they are still at record lows. GBP may have moved, but there is still plenty of juice in the tank as ‘Brexit’ hedges are still very much in the market.
With GBP/USD spot trading shy of $1.4800 we can buy a $1.4800 call and put (expiring this Friday) for a cost of 748 points. To breakeven on ‘buying volatility’ (using a ‘strangle’ strategy) we need GBP/USD to close above $1.5548 or below $1.4052. Of course GBP/USD implied volatility being near all-time highs is a key input in options pricing, but the mentioned range is a huge consideration and gives an idea on the potential moves by the end of the week. Clearly if you are of the view that the UK referendum is the next Y2K then selling volatility is probably a compelling trade. With unlimited risk in selling volatility this is a strategy I will not go near!
The divergence between the bookies and polls is something that many focus on. Taking into consideration what we have seen with the overnight night’s polls we are staring at something very close indeed. The poll of polls, which accounts for the average of the last six polls is literally 50:50. Britain Elects (follow them on Twitter) has the ‘remain’ vote just ahead at 50.8% to 49.2%, if one is to exclude the ‘don’t know’ vote. The polls are tight.
The bookies odds have a much closer correlation with GBP/USD, which you can see from the Bloomberg chart. I believe this a dangerous strategy, especially when it comes to betting exchanges rather than the fixed odds firms.
Take comments from the head of Ladbrokes (LON:LAD) overnight, who recently detailed that 75% of the money (value) staked had been on for a ‘remain’ vote, but the majority of bets were actually for ‘leave’. The average bet size for ‘remain’ therefore has been close to £450, relative to £70 for ‘leave’. How can this actually be reflective of an actual vote? Surely it’s more accurate to look at the absolute number of bets and not the sheer value. Can we therefore trust the bookies odds as a guide?
In terms of timings, things heat up right on the close of the voting stations at 0700 AEST, with YouGuv releasing an ‘On-the-Day’ or ‘call back’ poll, similar to the fairly accurate poll they ran for the Scottish referendum - This will be released on Sky News. We then get wind of the first vote count at 09:30 AEST, with the numbers increasing in frequency from 10am AEST and the open of FTSE futures and ASX 200. This chart from Nomura highlights the times well, although you will need to adjust from UK time. We should have a pretty good idea of who is going to win the referendum by 12:30 to 13:00 AEST.
Is this another Y2K moment?
Perhaps, although a vote to ‘leave’ should result in a strong pick-up in volatility and I would be expecting a huge rush for safe haven assets, such as US treasuries and gold.
- EC President Donald Tusk warning of an end to ‘Western political civilisation’. Seems a touch OTT.
- George Soros talking about the next ‘Black Friday’ on a leave vote. He’s long gold, surely he wants a ‘leave’ vote?
- London workers queuing up to change out of sterling. This seems very strange given the spread they would pay would offset the money they would save from avoiding a drawdown in GBP, read more here
- George Osborne suggesting he wouldn’t be averse to suspending the LSE if things got out of hand. This seems a bizarre thing to do as it would push traders to hedge in other markets, read more here
- A number of key note central banks saying they will provide liquidity to money and FX markets should liquidity dry up. Reassuring comments.
G7 to issue statement if Britain votes to exit EU - sources - Reuters News
Another Y2K moment cant ruled out given the magnitude of the commentary that has been heard of late, but if we genuinely get a ‘leave’ vote then I would expect sizeable moves in assets and a rapid tightening of financial conditions.
Markets in focus?
As mentioned in prior notes the market I feel is most important is the Spanish/Italian bond yield spread relative to German bunds. A vote to ‘leave’ would cause this spread to widen aggressively and European banks will be smashed. The DAX, MIB and IBEX will be savaged on the idea of concerns around the asset quality on their balance sheet. CDS on Euro banks will spike and we are back to the talk in January around the sustainability of certain financial institutions.
Keep an eye on the open of the HK market, notably how HSBC Holdings (LON:HSBA) PLC A (NYSE:HSEA) and Standard Chartered (LON:STAN) trade, as these will be a proxy of the banking space. The cash market opens at 11:30 AEST.
GBP/USD could start having big moves from around 10am AEST and depending on liquidity we could see rapid moves on headline risk. The technical set-up is clearly bullish and I would be targeting a measured move into $1.4950, but I wouldn’t read into this at all as this assumes the bookies are correct.
Short EUR/AUD seems like a compelling trade. If we see a vote to leave then the EUR should weaken on the idea of political contagion through Europe, although a sharp pick-up in the VIX could see carry models unwind high yield plays. A vote to remain would see higher yielding assets outperform and the prospect of an August cut from the RBA would fall from the current probability of 37%.
IG continues to make a market on European equity markets during the day, so these will be closely followed. Euro Stoxx futures open at 16:00 AEST.