© Reuters. Never-Ending Brexit Sends Traders to Far-Flung Market Corners
(Bloomberg) — As Brexit sends hedging costs soaring again, strategists are recommending a slew of less crowded ways to trade the never-ending political drama.
From euro-area bond spreads and equity derivatives to the shape of the inflation curve, investors can place bets on Britain’s economic future, without speculating directly on its volatile currency.
As the nation heads toward a no deal with the European Union, U.K. Prime Minister Boris Johnson is still holding out room for more negotiations this year, spurring investors to prep for fresh political fireworks.
With that in mind, here are some alternative investing styles to trade the torturous negotiations.
For the deal pessimists, selling Irish sovereign bonds to buy French government debt looks like a good hedge, according to JPMorgan Chase (NYSE:) & Co. Ireland’s economy is far more dependent on the U.K. than the latter’s continental neighbor, therefore its yield typically rises relatively more when no-deal talk pummels the pound.
Investors can make bets on the inverted correlation between the Irish-French bond spread and sterling, while deal optimists can go the other side of the trade.
In the equities world, one view holds that the should suffer relatively less than the Stoxx Europe 50 Index on no-deal fears. That’s because a cheaper pound tends to cushion the impact on U.K.-listed multinational stocks, more so than the comparable dynamic in the euro-area index.
As such, sell-side strategists have recommended selling puts on the FTSE to buy them on SX5E. Right now, pricing appears to favor that trade with a benchmark put costing well above its five-year average relative to its counterpart, as measured in volatility terms.
One wild trade lives in market-derived inflation expectations. Traders are expecting higher price pressures over the next five years relative to the next 30, spurring an inverted yield curve. Retail price inflation is currently seen around 48 basis points more than in three decades time, near historic extremes.
All that could change under a trade agreement that fosters a pound rally, thereby easing the imported cost pressures, according to Bloomberg Intelligence global derivatives strategist Tanvir Sandhu.
Morgan Stanley (NYSE:) cross-asset strategist Andrew Sheets, for one, predicts a U.K.-EU deal in some form or another by early November, sending the pound back to $1.40 versus $1.30 currently. The upside for speculators is huge: The sterling options market on Monday flashed only a 2% probability this level would be reached by mid-November.
Any sterling-positive news in the weeks ahead therefore has the potential to jolt cross-asset trades, from bond spreads to inflation curves.
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