Brexit polls have traders bracing for more market volatility

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The British pound has been on a wild ride lately, leaving investors scrambling for a way to hedge their bets on the result of the upcoming referendum on Brexit.

On Monday, sterling fell 1.1 per cent against the U.S. dollar, before recovering somewhat, after two polls showed the campaign to pull Britain out of the European Union was in the lead. A YouGov poll put support for Vote Leave at 45 per cent, compared with 41 per cent for Remain and 9 per cent unsure. Another survey by ICM had Vote Leave at 48 per cent and Remain at 43 per cent. Betting shop Betfair has also increased the chances of Britain voting to leave to 30 per cent from 27 per cent a week ago.

While still largely within the margin of error, the polls signalled a shift in public sentiment toward Vote Leave. For weeks the Remain campaign to keep Britain in the EU looked to be in control of the June 23 referendum and the pound had been strengthening. Now, traders are bracing for more swings as polls change and indicators point to the highest volatility in trading in more than seven years.

"The next couple of weeks are only going to be extremely volatile," said Craig Erlam, a senior market analyst at foreign exchange trader Oanda.

Some analysts have predicted the pound could fall as much as 15 per cent in the short term if Vote Leave wins. That would send the currency down from the current level of about $1.44 (U.S.) to about $1.23, a level not seen since 1985.

To take advantage of the situation, many investors have turned to a variety of hedging strategies. Some are shorting the pound and the euro, on the expectation that if Britain votes to leave, both currencies will decline in value. At the same time, these investors are betting the Swiss franc and Japanese yen will strengthen on a Vote Leave result because they are considered traditional haven currencies. Others are trying to take advantage of the volatility leading up to the referendum by buying options on the price of the pound that expire just before the referendum.

In a sign of just how volatile trading could become, several foreign exchange firms have increased margin requirements for clients trading the pound, which limit how much risk they can take on.

"During events such as the upcoming Brexit referendum, market movements can be significant leading to the potential for large profits, but also large losses," Oanda said in a note to clients. The margin increase, the firm added, was done to "ensure our customers are more insulated from such movements."

Elsa Lignos, a senior currency strategist at Royal Bank of Canada in London, said relying on polls can be tricky. Many polls done online have shown more support for Vote Leave than polls conducted over the telephone, suggesting a problem with the methodology. Some online polls allow respondents to pick "don't know" while telephone polls do not. Ms. Lignos said the discrepancies have led to more volatility in currency trading.

"People were taking them a little bit too much at face value because we've had this difference between the online polls and the telephone polls," she said. "It was looking like Leave was falling in the polls or Remain was surging in the polls depending on how you were looking at it. And actually it wasn't anything of the sort."

She added that "for the past week, sterling has underperformed quite sharply and you've seen that exit risk premium being priced back into sterling."

James Athey, a fixed-income investment manager at Aberdeen Asset Management in London, said he is waiting for a clearer picture to emerge before making investment decisions based on polls.

"The margin for error is pretty large," he said. "Unless we are consistently seeing a 10-per-cent lead for one side, I think actually you are much more in the realm of 'this is a coin toss.' The margin of error on polls, the inconsistency of polls and just the variety of the results, you should have low levels of confidence in predicting either result."