Volatility and the British Pound

Volatility and the British Pound
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In June 2016, the electorate of the United Kingdom shocked the world by voting to exit the European Union by a narrow margin. Brexit was a rejection of the status quo and a vote that signified that citizenry of the U.K. did not want to accept political decisions made in Brussels or economic policy dictated from Frankfurt.

The initial reaction to the departure of the U.S. from the EU was ugly for the British pound which fell like a stone following the 2016 referendum.

Source: CQG

 

As the chart of British pound futures highlights, in June 2016, the pound dropped from a high of $1.50 against the dollar to lows of $1.3133. Over the months that followed, it continued lower reaching a bottom in January 2017 at $1.2001, the lowest level for the U.S. currency in decades. Uncertainty about the terms of departure which is a multiyear process caused the currency to cascade lower. London has been a financial hub for decades, if not centuries. The perception that other centers like Frankfurt, Paris, and other European cities would become the home for businesses presently in the U.K. caused economic uncertainty, and the pound reflected the market’s concerns.

However, following the early 2017 low, the U.K. foreign exchange instrument has rallied against the dollar and was trading at just under the $1.40 level as of February 23. The pound is now closer to the Brexit high than the lows seen just fourteen months ago. However, most of the price volatility in the pound has come against the dollar because the U.S. dollar has weakened dramatically compared to the euro currency since late 2016. While the pound has gained around 16.5% against the dollar since early 2017, the euro has moved slightly higher against the greenback over the period.

The negotiations for Brexit continue, and the U.K. and EU have yet to find common ground in terms of an amicable divorce. Some factions within the U.K. are arguing for another vote, while the government continues to negotiate with the other European leaders who are not in favor of making the British departure easy. While the pound has rallied against the dollar, there is as much uncertainty about the economic future of the U.K today, as there was back in June 2016 when they shocked the world.

It is likely that we will see the British pound become highly volatile at times over coming days, weeks, and months, as negotiations drag on and pressure comes from within the nation. Labor and Conservatives in the U.K. are not necessarily on the same side of the argument as Conservative Prime Minister Theresa May attempts to get the best deal possible for her country. Meanwhile, in Scotland and Ireland, many citizens feel closer to the EU and would like to remain part of the Union and separate from the British. All of the drama adds up to the potential for lots of volatility in the British pound in the future.

I expect a wide trading range in the pound versus dollar relationship as well as the pound euro exchange rate. Volatility in markets create opportunities for traders. When it comes to the currency markets, uncertainty makes the pound an excellent vehicle for nimble traders with their fingers on the pulse of the political and economic landscape these days as the two sides work their ways through the Brexit process. 

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