The gains the US dollar registered in the second half are being pared, but it is sterling's strength that stands out. It is difficult to attribute it to Obama's push against Brexit, but there does appear to have been a change in sentiment.
Sterling is the best-performing currency not only today but for the past five sessions, rising 1.25% against the US dollar to its best level since mid-February. The next target is $1.4600 and $1.4670, the high from early February. Sterling is rising against the euro for the eighth consecutive session. The next target for the euro is near GBP0.7685, which corresponds to the 38.2% retracement of the euro's rally off the mid-November low near GBP0.7000.
However, investors need to be careful extrapolating too much from the decline in the benchmark three-month volatility and call-put skew. The issue here is the calendar. Three-month optionality goes well beyond the referendum, which has now moved within the two-month window. The pressures have been squeezed into two-month duration. Two-month sterling volatility is at new six-year highs today, reaching more than 14.5% earlier, surpassing three-month volatility which has fallen below 13%.
Similarly, the call-put skew (25 delta risk-reversal) is being reduced in the three-month options and rising sharply in the two-month period. In the three-month period, the premium for sterling puts over calls finished last week at 4.45% and is now quoted near 3.68%. The 2-month skew favors sterling puts by 3.8% compared with 1.22% before the weekend.
The news stream remains light ahead of tomorrow's conclusion of the FOMC meeting and Thursday's BOJ conclusion. Many observers seem to be exaggerating how important the former is for the latter. Recall that the Fed's rate hike in December, and indications at the time that most at the Fed thought four hikes this year would be appropriate, did not deter the BOJ from adopting negative interest rates at the end of January. Nor did the ECB easing in early December preclude the Fed from tightening a fortnight later....MORE