As we head into the last hours of the EU Referendum, volatility is extremely high. The team at Morgan Stanley sees pound hedges as becoming obsolete and they see UK fundamentals as pointing to lower ground. Will we have a “buy the rumor, sell the fact” on a remain vote?
Here is their view, courtesy of eFXnews:
GBP has reached a six-month high after gaining 3.4% this week. Betting markets are suggesting the odds of a remain vote are at 76%.
It was only one week ago when GBP two-week implied volatility traded at a higher level than during the Lehman crisis, suggesting that investors were paying for expensive hedges. Now as the probability for the UK staying in the EU has improved, these hedges have become obsolete.
GBP/USD traders need to look at 1.5027 (November low) when controlling risk of short GBPUSD positions.
In our opinion, GBP is overvalued as GBP-supportive interest rate and yield differentials are inadequate to help to fund the UK’s 7% GDP current account deficit. For foreign investors to be attracted by the UK they need to have a yield advantage. Unfortunately this is not currently offered, with the 10y UK gilt yield being 39bp below that of the US Treasury. Therefore it may be difficult to fund the current account deficit via the yield angle, requiring FX weakness to make UK investments attractive. Note that the UK’s current account deficit is currently 4% of GDP lower than the US. Current GBP levels have put this currency in an asymmetric position where the downside potential is a multiple of how much GBP can gain.
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