Market News & Analysis
Sterling rates show ‘No-deal’ complacency remains
Ken Odeluga August 13, 2019 11:12 PM
In terms of pound capitulation, perhaps the worst is yet to come
With Boris Johnson pledging billions of pounds in public funding within weeks of becoming Britain’s Prime Minister Westminster and markets are preparing themselves for the possibility of an election sometime this year. The opposition Labour Party has made it clear it will seek to table a no-confidence vote in the government as soon as Parliament reconvenes from the summer recess, in September. At the same time, Johnson and his cabinet are adamant that they will steer the country out of the European Union by the 31st October deadline without a deal if necessary, if Brussels continues to refuse re-negotiations of the Northern Ireland backstop.
The ensuing collapse of the pound to multi-decade lows has come in tandem with unmistakeably dovish signals from the Bank of England. If BOE policymakers act as they have suggested they will in the event of no-deal, it is striking that rate expectations are ambiguous, suggesting that the risk of a no-deal Brexit is not fully priced in.
- Overnight Index Swap rates (OIS) rates are most sanguine. The swaps are mostly used by banks to gauge and offset credit risk whilst lending to each other. At last check, implied probability of a rate cut is slightly below 60% for the Bank’s December meeting at. A 79.1% cut probability is indicated for the BOE’s June 2020 meeting. Even then, the implied probability of a 25bp rate cut for June is just 38.1%. In fact, probability of a 25bp cut of the Bank rate to 50bp at any meeting between September 2019 and June 2020 inclusive, never reaches 50% according to OIS, peaking at 44% for the December meeting, when the probability of any cut is 58.6%.
- Interpretation: OIS pricing does not appear consistent with an acceptance that Britain could crash out from the European Union without a deal on Halloween. An alternative interpretation is that even if no-deal happens, negative economic impact can be contained enough to avoid the need for a rate cut. This barely seems credible. Even the consequences of a short-term economic shot will linger. Furthermore, it is highly unlikely that the BOE would refrain from policy easing if the UK exits the EU without a deal in coming months. As such, the better interpretation is that the OIS market does not fully price a rate cut this year because it does not expect Britain to leave the EU without a deal by the end of the year.
- Sterling forward rates - contracts designed to protect the value of a cash holding over a specified period - are less optimistic. Sterling/dollar forward rates begin to fully price the probability of a BOE rate cut somewhere between policymakers' December meeting and the one scheduled for 30th January 2020 as illustrated below. After a 25bp cut either in December or in late January no further 25bp cuts are fully priced all the way till this time next year.
2019 BOE rate cut probabilities implied by GBP/USD forward rates – 13th August 2019
Source: Bloomberg/City Index
BOE rate cut probabilities implied by GBP/USD forward rates – 13th August 2019
Source: Bloomberg/City Index
- Interpretation: There are probably several different reasons for the disparity in expectations between sterling rates markets. It is certainly possible that the forward market, which probably serves corporations and non-bank institutions, is effectively more risk-averse to rate expectations than the OIS market, which generally concerns lending between banks.
- Conclusion: Either way, one important takeaway from these data is that despite the recent slump of sterling to its lowest in 34 years, pockets of 'holdouts' remain. In other words, with OIS data implying a significant part of the market is not pricing in a no-deal Brexit, the pound could yet slump to even deeper historic lows, if that event begins to look more imminent.
This report is intended for general circulation only. It should not be construed as a recommendation, or an offer (or solicitation of an offer) to buy or sell any financial products. The information provided does not take into account your specific investment objectives, financial situation or particular needs. Before you act on any recommendation that may be contained in this report, independent advice ought to be sought from a financial adviser regarding the suitability of the investment product, taking into account your specific investment objectives, financial situation or particular needs.
GAIN Capital Singapore Pte. Ltd., may distribute reports produced by its respective foreign entities or affiliates within the GAIN Capital group of companies or third parties pursuant to an arrangement under Regulation 32C of the Financial Advisers Regulations. Where the report is distributed to a person in Singapore who is not an accredited investor, expert investor or an institutional investor (as defined in the Securities Futures Act), GAIN Capital Singapore Pte. Ltd. accepts legal responsibility to such persons for the contents of the report only to the extent required by law. Singapore recipients should contact GAIN Capital Singapore Pte. Ltd. at 6826 9988 for matters arising from, or in connection with the report.
In the case of all other recipients of this report, to the extent permitted by applicable laws and regulations neither GAIN Capital Singapore Pte. Ltd. nor its associated companies will be responsible or liable for any loss or damage incurred arising out of, or in connection with, any use of the information contained in this report and all such liability is hereby expressly disclaimed. No representation or warranty is made, express or implied, that the content of this report is complete or accurate.
GAIN Capital Singapore Pte. Ltd. is not under any obligation to update this report.
Trading CFDs and FX on margin carries a high level of risk that may not be suitable for some investors. Consider your investment objectives, level of experience, financial resources, risk appetite and other relevant circumstances carefully. The possibility exists that you could lose some or all of your investments, including your initial deposits. If in doubt, please seek independent expert advice. Visit cityindex.com.sg for the complete Risk Disclosure Statement.
Cryptocurrencies are not legal tender currency and trading of derivatives on Cryptocurrencies are currently not covered under any regulatory regime in Singapore. Consequently, investors should be aware they do not have protection under the Securities and Futures Act (Cap. 289). Please ensure that you are fully aware of the risks.