GBP/USD edged higher on Friday after recovering from earlier losses, as risk sentiment improved on talk of a possible US-Iran peace deal. The pair was trading around 1.3460 at the time of writing and was set to finish the week broadly unchanged.
Reuters cited a senior Iranian source saying a “political understanding” has been reached between Iran and the US but has yet to be finalised. The report followed claims that the two sides had agreed a proposed 60-day memorandum of understanding, which would extend the current ceasefire while reopening the Strait of Hormuz.
US-Iran Developments and Volatility Implications
We see the potential for a US-Iran understanding as a major catalyst for reducing market volatility. This improved risk sentiment generally weakens the US dollar, which acts as a safe haven during geopolitical turmoil. Therefore, we should consider strategies that benefit from a rising GBP/USD and, more importantly, a drop in expected price swings.
The most direct play is to sell volatility in the currency pair, as a finalized deal would likely crush the risk premium priced into options. One-month implied volatility on GBP/USD has already compressed from over 11% to near 8.5% this past week, and we expect it to fall further towards the year’s average of 7% if an agreement is confirmed. This pattern is similar to the period following the 2015 JCPOA agreement, which led to a multi-month decline in currency volatility.
Directional Trade Ideas and Broader Market Impact
For a directional view, we favor a cautiously bullish stance on the pound against the dollar, potentially using call spreads to limit costs. A deal would be fundamentally risk-on, weighing on the dollar while supporting global growth-linked currencies like sterling. The pair could target the 1.3600 level in the coming weeks if the current momentum holds.
The reopening of the Strait of Hormuz is also critical, as it would apply downward pressure on oil prices. Brent crude has already fallen 6% to $89 per barrel on these reports, and a sustained drop would act as a global disinflationary force. This could ease some pressure on the Bank of England, even as recent UK wage growth data came in hot at 4.1%.
Given this, the most reliable strategy appears to be shorting volatility, as the directional outcome for GBP is slightly clouded by domestic inflation concerns. While the path of least resistance for GBP/USD is likely higher due to a weaker dollar, the decline in implied volatility seems the more certain outcome. We will be watching for official confirmation of the memorandum of understanding before adding significant new positions.
