BNY Mellon: Evaluating Stress Levels in GBP

Oct 29, 2018

By Simon Derrick, Chief Currency Strategist, BNY Mellon

With GBP trading down toward its lowest level against the USD this year (and beyond that, June of last year) it’s worth considering some key numbers:

Market Positioning

The summer saw a sharp reversal in GBP futures contracts positioning by non-commercial players on the CME, according to CFTC data. Having held the longest net position since the early summer of 2014, a sharp sell-off emerged in April that continued until mid-September. By this point, the net short stood at levels similar to those seen just after the Brexit vote in 2016. However, there has been some moderation in the net short since then, leaving current positioning at levels not dissimilar to that seen in August of last year.

Our iFlow data shows a distinctly different pattern to that seen in the CFTC data, with the latest GBP sell-off only really emerging during the summer as the concerns over the Chequers agreement mounted. Much like the CFTC data, something of a recovery in sentiment toward GBP emerged in mid-September. Since the October 17 EU summit, however, renewed outflows have begun to emerge as investors have become steadily more concerned about the lack of agreement between the EU and UK on the divorce deal (see chart below).

Options Pricing

A little more detail about where the stresses are emerging.

The level of these stresses can be seen from the latest moves in both GBP/USD at-the-money-forward implied volatility along the curve from one to six months long with the 25 delta risk reversals over the same period. In both cases, there has been a real widening out of the spread between the one-month prices and the other main dates along the curve - with the former staying relatively stable over the past few weeks. This suggests that the concerns that are now beginning to build are really focused on what happens in the immediate run up to the new year and beyond.

It’s also worth noting that the six-month pricing indicates a similar level of stress to that seen in the market in February 2016 as the referendum campaign first began to heat up.

Behavioral Data

Since 1971 GBP has only seen 309 closes below the August closing low of USD 1.2696.

The average reading of 21-day realized volatility (measured on a close-close basis) for these days comes in at 12.74% (see chart below). This compares to an average reading of 8.55% since 1971 and a reading on Friday of 7.79%.

GBP spent the period from early July to late August 1984 trading between USD 1.30 and USD 1.34. When it finally resumed its downtrend at the very end of August, it took six months for it to reach its recorded all-time closing low of USD 1.0520.While brief periods of consolidation did emerge within this downtrend, the overall pace of decline was a steady one.