LONDON – Chances of the Brexit saga coming to an early end are fading fast. Investors should resign themselves to the prospect of an unpredictable last-minute showdown.
The United Kingdom’s Prime Minister Theresa May on Wednesday won a vote of no-confidence within her own Conservative Party, sparked by a disagreement over the divorce deal she reached with European Union leaders late last month. But more than a third of her own parliamentarians didn’t support her, laying bare the long odds of her getting signoff for the deal in anything like its current form.
The fate of Brexit increasingly looks like it will be decided dangerously close to the March 29 deadline – too close to give businesses time to plan for anything but the worst.
More and more investors are assuming a brace position in currency markets. Beyond headline moves in the pound – it has now fallen 2.8 percent against the United States dollar this quarter – options markets are pricing in a messy few months.
Money managers often use options to insure against swings in stocks, bonds or currencies. Over the past few months, as May has attempted to negotiate a Brexit deal and then pass it through the British Parliament, investors have bid up options contracts that protect against volatility in the pound – especially those that offer downside insurance.
Moreover, they have also been lengthening the period over which they are purchasing this insurance. Contracts expiring in January are now far less in demand than those with a maturity of either three months – right before March 29 – or longer.
The largest UK stocks, which make the vast majority of their sales outside of the UK, have been overly maligned and may be a good bet for value-oriented investors. But there’s little that investors can gain from being exposed to sterling, at least for the next few months.
A few months ago, it wasn’t unreasonable to think that the pound was so weak that it offered more upside if an agreement was reached than downside if there was a disorderly exit from the EU.
But it is becoming increasingly clear that any deal will leave a more complex situation behind – one that would take years to clarify through politically-fraught negotiations.
Investors should even be wary of a scenario where the 2016 popular vote is overturned and Brexit is called off – which is more likely after EU courts confirmed the UK could do it unilaterally – because it could fuel another disruptive wave of antiestablishment feeling.
This will be a tense series finale. It’s better that investors watch from afar.