Pound Traders Are More Riveted by BOE Than Cloudy U.K. Politics

When trading the pound, anything coming out of 10 Downing Street may be easily overshadowed by what Mark Carney has to say.

For all the latest talk on U.K. politics and the spillover on sterling, price movements on Monday in both the spot and option markets suggested monetary policy sits firmly at the epicenter of attention. 

A higher open for the pound in the Asian session was expected as talk of a cabinet reshuffle did the rounds over the weekend. In such a scenario, U.K. Prime Minister Theresa May’s position would in theory be stronger and a quicker resolution on Brexit negotiations could be achieved.

Yet it wasn’t until traders responded to reports that the Office of National Statistics would upwardly correct previously released labor data that the pound’s rebound gained traction. The revised employment data out of the U.K. signaled that the Bank of England might have to tighten policy at a faster pace than currently priced in.

Soon after the confirmation that labor costs were underestimated, sterling extended its run. The market was then largely unresponsive to news that May’s spokesman said she has full confidence in Chancellor of the Exchequer Philip Hammond and Foreign Secretary Boris Johnson.

At the same time, the shift in sterling’s volatility term structure showed the greater importance traders are assigning to monetary policy rather than Brexit negotiations. Early on Monday, the increase in demand on one-month implied volatility that captures the meetings by both the BOE and the Federal Reserve outweighed all other tenors.

Demand for long gamma trades eventually faded amid a U.S. and Japan holiday. The two-week tenor, which for the first time covers the aftermath of an European Union summit on Oct. 19-20, reversed its Friday gains while staying around 2.5 percentage points lower compared to the one-month.

The fifth round of Brexit talks begins this week with subdued expectations over imminent or significant progress. Even as the E.U. summit may show that the current impasse in negotiations is to remain for some time to come, two-week risk reversals rebounded to reduce bearish bets on the pound.

However, options market bets are likely to stay in favor of pound puts even as the BOE looks toward another hawkish meeting next month, as dollar strength continues on expectations that the Federal Reserve will hike again by the year-end.

  • NOTE: Vassilis Karamanis is an FX and rates strategist who writes for Bloomberg. The observations he makes are his own and are not intended as investment advice

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