The cliched response to the UK election result was that Brexit uncertainty had been removed; this was what explained the immediate rally in Sterling and UK stocks, and a sell-off in Gilts.
But only a couple of days later we found ourselves straight back in a world of volatility:
The gain in Sterling which had seemed so obvious given the election news was erased:
As was the 1.5% (or around two years’ worth of yield) in UK ten-year Gilts:
In reality, the only ‘certainty’ is the one that always exists: that markets will move on short-term noise. And, so long as Brexit remains an emotive tribal issue, many of these moves will be interpreted as the market’s verdict on the latest twists and turns in the Brexit saga.
Consider how many times we have read of Sterling ‘plunging‘, ‘tumbling’ or (less frequently) ‘surging’ over the last five years.
And yet it is hard to pick some of the biggest news stories out on a chart. In terms of the spot rate versus the US Dollar, a host of other factors have been far more significant than UK politics since the referendum, while the spot rate versus the Euro has been relatively stable:
On an even longer time scale moves in Sterling since the referendum itself actually look relatively muted:
And if we go back even further still, we can see the big shift in the currency volatility dynamic that has taken place:
We have discussed before how the global regime of benign inflation outcomes, more open economies, and shared policy making approaches have been part of an environment of far lower currency volatility than has existed in the past. And yet I suspect that many, if asked, would consider the environment for Sterling in the last four years to have been unusually volatile.
How do you position yourself for Brexit?
Yet, despite the fact that we can observe that a whole host of other factors can be more important than Brexit in the path of currencies (and other assets), and that many of the day to day moves which are presented as significant amount to little more than noise, there is still a powerful temptation to try to adopt a portfolio position to deal with this single issue.
Worse, we seek to hedge against the one risk that everyone is most aware of and is therefore most likely to already be priced in. Past posts have touched on the dangers some of these attempts to hedge have had, most recently in October (a post which also highlights the challenges of trying to read to much into short term price moves).
Of course currency moves can be significant, especially if exposures are large or time horizons are very short (which can amount to the same thing). However, for those who are not day traders it is better to acknowledge that uncertainty comes from a variety of sources, not just the ones in the news every day. Very often the only way to protect against such ‘known unknowns’ involves paying up for the privilege.
We all want comfort that someone knows what will happen on the most salient issues, or at least can remove the risks that keep us up at night. Unfortunately – as the last week has shown – uncertainty is never removed, even when we may think we have more clarity on ‘known unknowns.’