U.K. Election Volatility Traders See Little Risk of Labour Win

The sterling rates options market isn’t pricing any risk premium heading into Thursday’s election in the
U.K., despite recent polls showing a narrowing race.

Sterling rates implied volatility has fallen in recent weeks to the lowest since 2013, which is unusual compared with price spikes around previous political events. Though poll
surveys have been inconsistent, most have shown increasing support for the opposition Labour Party.

An outright Labour victory remains a tail risk given they need to win over 90 seats, while a hung parliament is no longer a remote tail risk given the recent tightening in polls. With
10-year gilt yields currently at 0.98 percent, the rates market is probably pricing a small Conservative Party majority.
* Sterling 3-month 10-year implied volatility at 3.46 basis
points (daily), close to all-time lows, given low realized
volatility with 1-month at 2.6 basis points (daily)

* A hung parliament leading to a Labour-led coalition could mean
a potential increase of 25 basis points on 10-year gilt yields,
following an initial flight-to-quality, with increased odds of a
softer Brexit, fiscal stimulus and heavier supply; while an
outright Labour majority would have an amplified effect that
could lead to an increase of 50 basis points

* Short-dated sterling FX implied volatility has increased in
the past month but is still far below recent peaks; 1-month
GBP/USD and FTSE 100 implied volatilities are at their 35th and
34th 1-year percentiles (10-year rates implied vols at 0
percentile)

* Even with a surprise outcome, realized volatility should quickly fall and the market may re-initiate short volatility positive carrying strategies.

Source: Bloomberg Pro Terminal

Trader - Senan Fuchedzhiev

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