Sterling traders bet Brexit trade deal will be done, despite the brinkmanship              

A number of new advisory groups have been set up to support the UK's post-Brexit trade talks, it has been announced. File photo

Sterling traders who have grown used to Brexit brinkmanship between London and Brussels are making two assumptions: There’ll probably be a trade deal, and US elections matter more right now.

It’s spurring demand for pound-bullish option bets and putting a kink in the currency’s volatility curve, which peaks at the one-month tenor. 

That’s well beyond the UK’s self-imposed October 15 deadline to strike an accord with the EU, but just in time for the November 3 vote in the US. 

Britain and the EU have been at a similar impasse in the past, only to reach some sort of compromise at the very last minute. With signs that officials are more upbeat -- at least in private -- when it comes to the prospect of clinching a deal, there’s little reason to believe that this time will be any different, the thinking goes.

Meanwhile, the possibility of a contested US election is uncharted territory for markets, and deserves a higher risk premium given the stakes.

In a sign of the market’s positioning, sterling held its ground when the UK government warned this week it would pull out of trade talks with the EU if there is no clear deal in sight next week.

Risk reversals -- a gauge of market positioning and sentiment -- also show a familiar pattern unfolding when Brexit negotiations seemingly break down. 

Initially, demand for dollar upside exposure intensifies sharply when concerns grow, yet quickly retreats after the first round of hedging goes through.

Over-the-counter trades paint a similar picture. 

Investors are also going long volatility on structures that expire by end-October, early November, essentially betting that the pound may see large price swings around the US presidential elections, the traders said.

Data Friday showed the UK economy grew at less than half the pace anticipated in August even as the government stepped up efforts to revive the beleaguered hospitality industry.

Given concerns about the pace of the recovery, and lingering global risks, options gauges show sentiment over the pound remains bearish overall in the medium term. But for now, the latest bets show a clear preference for the currency.

The pound was steady against the US dollar in the latest session, brushing off worse than expected UK growth data as investors became more optimistic about a Brexit deal being reached ahead of a key European Council summit next week.

Additional reporting Bloomberg