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GBP could depreciate by 4% if Brexit uncertainty stays at current levels - Nomura

Discussion in 'Fundamental Analysis' started by FXStreet_Team, Jan 12, 2016.

  1. FXStreet_Team

    FXStreet_Team Well-Known Member Trader

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    FXStreet (Delhi) - Research Team at Nomura, suggests that while the timing of the first BoE rate hike is now likely to be delayed until H2 this year, we expect the 2yr rate spread to continue widening to GBP positive, as the ECB will likely be forced to ease again in June.

    Key Quotes

    “The 2yr rate difference between EUR and GBP is currently around -1.00-1.10%, but we expect this spread to shift toward the -1.25-1.50% range over the next 3-6 months.

    Future implied volatility movement is less certain. However, 1yr implied volatility spread has already shrunk rapidly to around 0% now from 3% as of mid-2015, as the market assumes the referendum will be held within the next 12 months (Q3 is likely consensus, see “Client views into year-end”, 16 September 2015).

    While we do not expect the referendum to be held within the next six months, the 6m implied volatility spread has also declined to below 1%. While the 3m implied volatility spread is currently around 2%, the spread is expected to decline at least toward 0-1%, as the timing of the referendum (we expect September) approaches, unless a meaningful positive shift in opinion poll results occur.

    If GBP/USD implied volatility spikes further as a result of higher expectations for Brexit, the spread can turn to even negative. Given the higher uncertainty over the “Brexit” decision than the Scottish referendum and General Election, volatility spreads can move even more if opinion polls tilt further toward “leave”.

    If GBP/USD 3m implied volatility spikes by 2pp relative to EUR/USD implied volatility into the referendum, we estimate the impact of 25bp of widening in the 2yr rate spread is will be offset completely (from 0.750 to 0.753). If the increase in GBP/USD implied volatility is more muted (for example 1pp) owing to lower expectations for a Brexit or more support for “stay” in opinion polls, monetary policy divergence will be a stronger driver of EUR/GBP (from 0.750 to 0.739). In contrast, if opinion polls suggests an even higher possibility of a “Brexit” and volatility spikes by 3-4pp, EUR/GBP could break 0.80. Under this scenario, the BoE would likely need to be even less hawkish and the rate difference could also work negatively for GBP against EUR.

    The analysis focusses on the impact of uncertainty into the referendum, while the actual impact of a Brexit decision, albeit unlikely in our view, would be larger. Nonetheless, ahead the referendum, the sensitivity analysis gave us a good idea of how to trade Brexit uncertainty in the FX space, in our view.”
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