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This is when the UK’s population will decide on the future of our EU membership and apart from the rush of politicians announcing their support for in or out, the Foreign Exchange Markets have spoken by sharply selling off sterling on the announcement.
If we look deeper into the markets response, we can see a sharp move up in the pounds volatility, to levels not seen since the 2015 general election, as fears of a possible exit gets priced in.
Since the end of 2015, investors have been looking at ways to sell sterling denominated assets, if the pound drops below a certain level. By buying ‘Put’ options on sterling, the holder has the right to sell the pound at a predetermined value in the future if they wish to do so. The use of options is one of the many types of derivative products available in the marketplace that allow companies and investors to hedge their currency exposure.
Recent polls have the ‘In’ camp slightly ahead, but given the likelihood of more scare stories from both sides, we are likely to see large swings in the pound during the run-up to the vote. One of the scare stories that recently hit the press was the view of US Investment Bank, Goldman Sachs. Their research team concluded that the pound could fall by as much as 20% if we exited the EU as investors rushed to sell sterling denominated assets.
Between now and June, the pound will no longer largely trade on expectations of the Bank of England’s interest rate policy, but more on fear of the unknown. So in essence, the market will focus on the latest views of the general public rather than fundamental news from the economy. So fully expect a bumpy ride for the pound over the coming months, as the market interprets the changing political rhetoric on a daily basis.
Obviously, nobody knows for certain the likely result of the vote, nor how the market will react afterwards. But this uncertainty does pose a problem for any business that has exposure to the FX market. This could be an importer of goods that may see his profit margins swing around by an uncomfortable amount on a daily basis.
With so many hedging options available from simple to complex Derivative products, the time for unbiased regulated advice is more important than ever. Many brokers could be pushing the idea of overly complicated products that are not tailored to the specific requirements of the end user but more on their sales targets. This could lead to hedges being implemented that are not suitable and have undesirable risks depending on how the vote plays out.
The use of Derivatives for hedging, if done correctly, is an extremely useful method to eliminate unwanted financial risks. Without them, these risks can be very distracting for a company that has exposure to the Foreign Exchange market, as profit margins are changing on a daily basis. However, these hedges must be researched properly, and the benefits and risks associated with them clearly calculated and explained.
At Vedanta Hedging, we pride ourselves in offering independent and unbiased advice with regards to hedging. We believe these products should not be unnecessarily complicated, and that you fully understand what you are entering into, as well as the benefits and limitations of each strategy. We can also verify that the price of your hedge is fairly priced because we have the same live market feeds and software as the banks and brokers.
Whether or not you decide hedging is right for your company, it is imperative to seek regulated independent advice to give you all the information you need to make an informed decision that’s best for your business.
