STERLING - A HIGHER GBP EQUILIBRIUM: BREXIT, DATA, VOL, RATES
GBP moving higher?
Data:
1. Leading post brexit data has recovered significantly from 5-10yr lows to firm growth or significant recovery (PMI, Optimism, Confidence) and imo this will be continuing theme given negs arent going to start for another 6-9m, there isnt any impetus to drive us lower again.
2. Also the macro indicators are trading well, e.g. Inflation, employment and GDP are all firm, assuming this continues further BOE action will be impossible & general sterling selling will struggle.
Negotiations:
1. EU Exports equal 50% of total exports whilst total exports equal 10% of GDP, so even if we lost all EU exports GDP would only fall by 1% given imports are marginally less than exports thus the cost of losing EU trade is offsetted, its not all one way. UK Domestic demand would pick up the EU import slack so likely only 1% to GDP to be lost.
- That is the absolutely worst option. In reality we know negotiations will only realistically lead to at worst international trade inefficiencies e.g. duties/ taxes, which will likely have a less then 0.1% effect on GDP. The EU isnt going to cut all ties.
- Also from this point, and GBP 10-20% lower uncertainty is priced so further downside from uncertainty is hard to justify unless we get new political stimulus which is unlikely given how quiet it has been to date. So risks here look to be to the upside e.g. uncertainty/ complacency fading meaning confidence/ optimism rises in the near term (even if wrongly), which sees GBP wash off some of this "gap" and move to a new near term equilibrium.
GBP price action:
1. STG crosses have lost 2-4000pips or more in the past 6m, so is relatively very undervalued, thus a 500-1000pip rebalancing higher wouldnt be uncalled for or even relatively aggressive.
2. Topside is also supported by the price action we have seen post brexit, apart from the initial brexit losses, any further downside (weak PMI, BOE easing etc) GBP has failed to hold the lows of the range OR even trade at the lower percentiles for any particular amount of time - we havent seen a new equilibrium lower in sterling weve remained rangebound with a topside skew. We have seen GBP brought quite aggressively on dips, and on reflection, it has actually paid to be a buyer on dips vs a seller on rallies from a risk perspective. Being a bear myself, I know it has been an upward battle to gain any consistent downside, all structural shorts have turned into tactical positions with early profit taking e.g. short GBPUSD for 1.25 was cut early at 1.29 when the bulls faded the move lower. This theme has been consistent despite BOE Easing and strong fwd guidance, with flimsy data.
3. The past week MA i think is much closer to where we will see GBP trade in the future vs the 1m MA at 1.319.. 1.334 on the weekly is where i feel we will find the next months average.
Data:
1. Leading post brexit data has recovered significantly from 5-10yr lows to firm growth or significant recovery (PMI, Optimism, Confidence) and imo this will be continuing theme given negs arent going to start for another 6-9m, there isnt any impetus to drive us lower again.
2. Also the macro indicators are trading well, e.g. Inflation, employment and GDP are all firm, assuming this continues further BOE action will be impossible & general sterling selling will struggle.
Negotiations:
1. EU Exports equal 50% of total exports whilst total exports equal 10% of GDP, so even if we lost all EU exports GDP would only fall by 1% given imports are marginally less than exports thus the cost of losing EU trade is offsetted, its not all one way. UK Domestic demand would pick up the EU import slack so likely only 1% to GDP to be lost.
- That is the absolutely worst option. In reality we know negotiations will only realistically lead to at worst international trade inefficiencies e.g. duties/ taxes, which will likely have a less then 0.1% effect on GDP. The EU isnt going to cut all ties.
- Also from this point, and GBP 10-20% lower uncertainty is priced so further downside from uncertainty is hard to justify unless we get new political stimulus which is unlikely given how quiet it has been to date. So risks here look to be to the upside e.g. uncertainty/ complacency fading meaning confidence/ optimism rises in the near term (even if wrongly), which sees GBP wash off some of this "gap" and move to a new near term equilibrium.
GBP price action:
1. STG crosses have lost 2-4000pips or more in the past 6m, so is relatively very undervalued, thus a 500-1000pip rebalancing higher wouldnt be uncalled for or even relatively aggressive.
2. Topside is also supported by the price action we have seen post brexit, apart from the initial brexit losses, any further downside (weak PMI, BOE easing etc) GBP has failed to hold the lows of the range OR even trade at the lower percentiles for any particular amount of time - we havent seen a new equilibrium lower in sterling weve remained rangebound with a topside skew. We have seen GBP brought quite aggressively on dips, and on reflection, it has actually paid to be a buyer on dips vs a seller on rallies from a risk perspective. Being a bear myself, I know it has been an upward battle to gain any consistent downside, all structural shorts have turned into tactical positions with early profit taking e.g. short GBPUSD for 1.25 was cut early at 1.29 when the bulls faded the move lower. This theme has been consistent despite BOE Easing and strong fwd guidance, with flimsy data.
3. The past week MA i think is much closer to where we will see GBP trade in the future vs the 1m MA at 1.319.. 1.334 on the weekly is where i feel we will find the next months average.
Comment:
Vol & Rates:
1. As seen in the bottom two windows, GBP govies have rallied +50% in the past 2 days, despite broad risk assets taking a hit on friday - this is consistent with view that GBP is becoming a safer investment vehicle and at these levels will continue to be an attractive investment, and that the economy isnt in as much of a bad shape as first feared. STIR e.g. Libor and OIS have remained pretty flat in the front end with OIS discounting another 5-10bps of cuts in the next few months, but mid term maturities e.g. 3yr, we have seen consistent steepening in OIS as the economic impacts are discounted following the firm UK data and increase inflation expectations.
2. GBP Index Vol is trading back at normal (pre-brexit) levels, this encourages the idea that GBP is becoming more and more of an attractive re-investment after the run on UK assets, especially with respect to the reinvestment/ speculation that i mention above. Low volatility increases the chances of the consensus "buy GBP assets cheap" view discussed above can become reality, and quicker at that.
1. As seen in the bottom two windows, GBP govies have rallied +50% in the past 2 days, despite broad risk assets taking a hit on friday - this is consistent with view that GBP is becoming a safer investment vehicle and at these levels will continue to be an attractive investment, and that the economy isnt in as much of a bad shape as first feared. STIR e.g. Libor and OIS have remained pretty flat in the front end with OIS discounting another 5-10bps of cuts in the next few months, but mid term maturities e.g. 3yr, we have seen consistent steepening in OIS as the economic impacts are discounted following the firm UK data and increase inflation expectations.
2. GBP Index Vol is trading back at normal (pre-brexit) levels, this encourages the idea that GBP is becoming more and more of an attractive re-investment after the run on UK assets, especially with respect to the reinvestment/ speculation that i mention above. Low volatility increases the chances of the consensus "buy GBP assets cheap" view discussed above can become reality, and quicker at that.
Comment:
Risks:
1. Brexit Negs are brought forward, and uncertainty is heightened. But even so I feel the risks here are actually to the upside, given the move lower is the pricing of uncertainty and IMO negotiations are likely to end up with a "not much has fundamentally changed" outcome VS "UK no longer does business with the EU".
- Also lets not forget the UK has a 2 YEAR "COOLING-OFF" WINDOW where NOTHING changes once negotiations begin/ A50 finishes. So i cant see GBP not having a move higher at somepoint within this 2yrs.. the uncertainty cant continue to trade heavy forever without new stimulus (e.g. rocky politics) plus Theresa May stated she isnt going to provide "running commentary" on discussions, which could work in or out of uncertainties favour.
1. Brexit Negs are brought forward, and uncertainty is heightened. But even so I feel the risks here are actually to the upside, given the move lower is the pricing of uncertainty and IMO negotiations are likely to end up with a "not much has fundamentally changed" outcome VS "UK no longer does business with the EU".
- Also lets not forget the UK has a 2 YEAR "COOLING-OFF" WINDOW where NOTHING changes once negotiations begin/ A50 finishes. So i cant see GBP not having a move higher at somepoint within this 2yrs.. the uncertainty cant continue to trade heavy forever without new stimulus (e.g. rocky politics) plus Theresa May stated she isnt going to provide "running commentary" on discussions, which could work in or out of uncertainties favour.
Comment:
Best expressions:
1. Absolutely NZD, AUD and JPY crosses have appreciated the most vs GBP some 4000pips+. Though I discount JPY as I see yen as cheap here (no further BOJ easing expected & Safe haven demand to increase).
2. Looking at AUDNZD cross, aussie looks extremely weak and continuing to parity, thus GBPAUD to 1.79 isnt necessarily a tail-end call. With only the 1.02 support level left in aussie kiwi 1.00 is the next level thus GBPAUD topside could follow.
3. Currently +20% is priced into USD fed funds for a september hike, so essentially a good proxy to play this near-term firming GBP would be vs USD. The 20% or so priced in will fade GBPUSD higher assuming a no hike, plus we have US election which may put downside on USD some more. So if you are inclined to bet against the fed in 2wks time short GBPUSD to 1.35 isnt a bad call imo, though I may wait for better entry in the 1.31xx if it opens up the chance. Obvious risk is that a Sept Fed hike occurs and sends cable likely through 1.30.
1. Absolutely NZD, AUD and JPY crosses have appreciated the most vs GBP some 4000pips+. Though I discount JPY as I see yen as cheap here (no further BOJ easing expected & Safe haven demand to increase).
2. Looking at AUDNZD cross, aussie looks extremely weak and continuing to parity, thus GBPAUD to 1.79 isnt necessarily a tail-end call. With only the 1.02 support level left in aussie kiwi 1.00 is the next level thus GBPAUD topside could follow.
3. Currently +20% is priced into USD fed funds for a september hike, so essentially a good proxy to play this near-term firming GBP would be vs USD. The 20% or so priced in will fade GBPUSD higher assuming a no hike, plus we have US election which may put downside on USD some more. So if you are inclined to bet against the fed in 2wks time short GBPUSD to 1.35 isnt a bad call imo, though I may wait for better entry in the 1.31xx if it opens up the chance. Obvious risk is that a Sept Fed hike occurs and sends cable likely through 1.30.
Comment:
GBPUSD longs from market yesterday up 80pips, still think its valid to hold for 1.34/5 or the 1.343 highs from last week.
1. Following brexit we saw a flight to safety, UK assets were sold the pound fell heavily. Howvever, there is/ has been much talk on "when" to and at "what price" GBP becomes a value investment, e.g. picking up real estate 10-20% cheap, or other GBP denominated assets cheap on the pretence of GBP firming back up again.
- Assuming the brexit sell-off was an over reaction (e.g. the economic downsides massively overstated which may be the case) this re-investment and STG topside speculation could be alot closer than we may think, especially when you consider that a "brexit no show" is gaining increasing odds, with not before 2021 odds now priced at 33%, which in reality means GBP devaluation here is extremely early if post 2021 did become the case. We would certainly see GBP move higher before moving lower a few years closer - www.oddschecker.com/...politics/article-50. Not before 2017 July at 48%.
2. When the market does decide that NOW is the price/ time that STG is cheap, we will no doubt see an aggressive move higher, foreign inflows will rally. The risks of this increase every day, especially when you consider the consistent carry risk of a brexit no show of being short. The bias is with the bulls, here, e.g. more to gain by brexit no show than bears to benefit from brexit negs starting.