For years the options market that companies and investors use to hedge against big swings in currencies viewed the euro as a bigger political and structural risk than Britain’s pound.

No more.

In the political and market turmoil immediately before and following Britain’s decision last June to leave the European Union, financial market investors flipped their long-held bias against the euro and now expect sterling to be the riskier party for years to come.

Reuters data going back to 2012 shows three- and five-year risk reversals — the cost of taking out an option to buy or sell the pound — have consistently been below zero.

That indicated it was almost always more expensive to hedge against the risk of euro exchange rates collapsing than of the same happening in sterling.

There are always blips. On a handful of occasions since Mario Draghi’s promise to do “whatever it takes” to prop up the euro in 2012, the single currency has briefly been valued as steadier for the long term.

But since an initial jump in the first six months of 2016, both three- and five-year euro-sterling risk reversal contracts have held consistently in positive territory, indicating the tail risk — the risk of a low probability, high impact event — is now instead with the pound.

That is the first time in Reuters’ historical data on the options market and means it will be increasingly costly for investors exposed to the pound’s exchange rate to insure portfolios against further slides.

With the pound pummelled by political and economic uncertainty, the euro/sterling five-year risk reversal EUGB5YRR= on Thursday matched its highest in 11 months, showing an increased bias towards sterling weakness.

This followed open disagreement among Bank of England policymakers on the outlook for interest rates and, by extension, the pound.

On Tuesday BoE Governor Mark Carney said now was not the time to raise rates, warning of weak wage growth as Britain prepared to quit the EU.

On Wednesday, the central bank’s chief economist, Andy Haldane, said he was likely to join those voting for a hike later this year.

Bankers are cautious about predicting further steep falls in the pound, but some senior currency market players wonder what will happen to sterling if Brexit talks turn bad.

Some in the sales teams that focus on selling cheap option plays to hedge fund investors wanting to speculate on currency moves say the change is reflective of the broad swing in political risk.

Source: Reuters

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