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Brexit risk premium return on UK market

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London (Reuters)-The recent neutralization between the UK and the European Union is raising demand from premium investors for UK asset holdings, fearing the confusing Brexit consequences of massive damage to the economy.

File photo: In this illustrated photo taken January 31, 2020, pound coins lie on broken glass and a British flag. REUTERS / Dado Ruvic / Illustration

The pound fell 4% against the dollar this month. UK stocks, options markets and bonds are also quickly setting Brexit premiums as the British Parliament is now starting to debate legislation that violates the EU divorce treaty and violates international law.

Brexit risk pricing is being filtered through interest rate futures and inflation expectations. Here are some examples of Brexit Premium:

1) Sterling implied volatility

Implied volatility, i.e. an option that shows investors’ expectations of future price movements of the currency, surged to sterling/dollar The one-month volatility, or volatility in trader terms, is about 12%, which is a five-month high, much higher than the implied volatility of other G7 currencies.

The one-month spike in trading volume reversed the options curve for the first time since March, indicating an increase in short-term risk and crossed the 12-month gauge.

Graphics: Pound implied volatility rises following new Brexit tensions-

The option, called a risk reversal, also shows a sharp rise in the volume premium inherent in buying sterling put options this month.

Graphics: Options market moves to “no deal” Brexit pricing-

2) stock risk

Shares have been underperforming since the UK voted in a referendum to withdraw from the EU in June 2016. This year, the FTSE index is 17% behind the European STOXX benchmark. In part, this is due to the high proportion of energy and commodity companies with poor performance. But Brexit is also responsible.

Graphics: UK stocks low in 2020-

The comparison of performance and valuation by industry provides evidence of Brexit Premium.

Looking at the UK energy or finance sector differences, for example, from other countries, we can see an additional risk premium in the UK, said Justin Onuekwusi, portfolio manager at Legal & General Investment Management.

UK assets look cheap compared to the rest of the world.

Graphics: UK vs. European bank evaluation-

3) Premium borrowing

Investors also want, among other things, to lend the Brexit premiums reflected in bank-issued bonds to UK companies.

For example, Barclayss’ September 2023 Euro denominated bonds and the same month maturing Deutsche Banknotes’ yield gap widened from around 38 bps to a high in nearly three months.

Graphics: UK Corporate Loan Premium-

ABN Amro analysts pointed out that spreads for euro denominated bank bonds expanded by about 3 bps last week, while UK lenders saw spreads plunge by 20-30 bps.

We expect Brexit negotiations to continue to make negative headlines. The UK risk premium is likely to continue rising for the remainder of the year, they told customers.

4) Curve steering

Brexit premia could also be included in the steeper UK gold leaf yield curve. Money Markets brought a bet on the Bank of England rate cut and set negative interest rates in early 2021.

Graphics: Money markets set negative interest rates from BoE in Q1 2021.

Looking at the British curve based on the Bund curve, the curve is now steeper. Other things are easy to move around, given that currency is cheaper and cannot be cheaper. The steep increase in the curve offers a premium, said Societe Generale analyst Kit Juckes.

Graphics: UK gold leaf yield curve sells out-

4) Inflation expectations

The market-based measure of future UK inflation GBIL5YF5Y = RGBIL10YF10Y = R is a pattern that emerged even after the 2016 referendum, which raised expectations for inflation with the pound crash.

Viraj Patel, Arkera’s global macro and monetary strategist, said the recent rise in inflation expectations coincided with the weakening pound, suggesting that this is related to Brexit and not due to COVID-19 reflation.

Graphic: UK inflation expectations are rising as the pound weakens recently-

Report by Ritvik Carvalho; Further reporting by Sujata Rao, Thyagaraju Adinarayan and Abhinav Ramnarayan; Compilation by Carmel Crimmins

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