Macro and Vol Commentary
Both currencies have been sold against the USD, but EURGBP has moved in favour of the EUR. Is there any upside for GBP?
- Data in both economies have slowed in recent months, as the cost-of-living crisis has taken hold. The UK continues to slow, with GDP for Q2 at 2.9% Y/Y and Q/Q growth at 0.3%. We expect Q3 data to continue this trend as the cost-of-living crisis hits consumer confidence.
- Data for July show that GDP grew by 0.2% after falling 0.6% in June. Production fell 0.3%, after a 0.9% fall in June as electricity, gas, steam, and air conditioning supply fell 3.4%.
- Retail sales, including auto fuel, continued to decline on an M/M and Y/Y basis, at 1.6% and 5.6%, respectively. Excluding fuel, retail sales are at 1.6% and 5% on an M/M and Y/Y basis, respectively.
- PMIs in the UK are contractionary; the manufacturing PMI is at 48.5 for August, slightly higher than expected at 47.5, and above July's 47.3. Production continues to fall, and weaker intakes of new business.
- Services and composite PMIs are also contractionary at 48.5 and 48.4. The recent weakness in sterling could prompt some demand for UK services, but confidence in the economy is poor, and this bounce may be limited.
- We do not expect these readings to rebound in the near term.
- Consumer confidence was -49, down from -44, which will decline after the government's announcement and their mini-budget.
- Central government NCR was 4.9bn in August, up from -1.7bn. The public sector net borrowing was 11.1bn, up from 4.2bn.
- Government borrowing is set to surge following the announcement last week, and this will cause the budget deficit to increase as their revenues will also decline due to lower tax income taxes.
- As energy and mortgage costs rise, we expect consumer spending to decline for the rest of the year. The higher mortgage costs will likely lead to rents increasing for tenants, which in turn will push CPI higher, and as a result, interest rates.
- House price growth is slowing and, on an M/M basis, at 0.3% and Y/Y at 9.9%. We expect house prices to fall in the coming months as higher mortgage rates could cause homeowners to sell their houses if they can't afford the mortgage.
- In addition, the cut of stamp duty on properties below £250,000 will likely inflate prices, which are already high, and those with a high LTV ratio will again be paying a high mortgage rate.
- The higher mortgage levels will reduce disposable income for families, reducing aggregate demand and compounding the downward spiral of the UK economy.
- CPI stands at 9.9%, and the weak currency will cause business costs to rise as they import inflation. Energy prices have declined, which will help, but the new policy from the government will likely increase inflationary pressures due to the weaker pound and higher living expenses.
- We expect inflation to remain high in the long run, which is in line with the BOE's intervention and comments.
- Certainty and confidence needs to be gained in the markets, and the BOE may have to continue to intervene, if the government continue with their plan. The PM is under pressure from conservative MPs to amend the policy. The November budget is an opportunity to do so.
- Labour currently have the largest lead in the YouGov polls for over 20 years, with the probability of Liz Truss being replaced this year at 13% and 60% next year.
Bank of England
- The implied rate change by the BOE stands at 1.6% for November, bringing the implied rate to 4.062%. For the December meeting, the implied rate was 4.914%, suggesting an implied rate change of 2.453%.
- The SONIA rate curve shows September 2023 as 6.015%, with September 2022 at 3.24% as of September 29th.
- The BOE had to intervene to purchase long-dated UK government bonds until October 14th. This caused the 30 yr yield to recover below 4% from a high of 5.143%.
- The intervention was merited due to the knock-on impact of the housing market, and this pain is likely to still be on the cards when you look at mortgage rates in the UK and run on a 20yr housing market cycle.
- The move also reduced stress on pension funds due to large margin calls.
Economic confidence in the EU and UK is low; however, the ECB have a clear plan they intend to execute, even if they are still behind the curve. The bloc is likely already in a recession, and we expect this to be confirmed by year-end. The EUR will remain weak against the USD. Still, due to the uncertainty in the UK economy and lack of confidence from the consumer and government, sterling will suffer against the EUR unless we see a change of course from the government. We have highlighted this year that the trajectory of higher rates was not damaging to the economy. Following the announcement from the government and recent moves, this view has changed, and ceteris paribus, rates towards 6% will damage the housing market and the wider economy. The decline in investment because of the weak pound and high rates could cause further issues for productivity, and foreign pension funds and organisations will likely buy UK assets. The BOE intervention has helped calm markets for the time being, which could make the weekly meeting between the Chancellor and BOE prickly. Still, markets have so far rejected the new government's spending plan of £72.4bn in borrowing and tax cuts that weren't necessary. The change in market sentiment indicates a loss of confidence highlighted uncertainty, and we favour owning EURGBP at this time, with a short-term target of 0.93 before the previous high of 0.95.
Sources: Office for National Statistics, S&P Global, GfK Consumer Confidence, Bloomberg
EURGBP cross has lately experienced a sharp increase in implied volatility across the whole options’ term structure, by the order of 4-5 Vols at the front-end over the last 10 days. This reflects high uncertainty on both fronts. Volatility started to increase on the GBP side following the mini-budget announcement, as markets require higher real yields to finance the resulting budget deficit – and thus GBP was one of the valves releasing volatility, together with yields. In this respect, the BoE is now expected to hike by nearly 150 BPs to the next meeting, in line with current market expectations and show commitment toward the inflation fight – and we expect this factor to play favourably for GBP in the near term.
On the other hand, Euro-land is still entrenched with sticky inflationary pressures (as shown by the latest September figures) and the energy crisis, which is likely to play down on EUR as we enter into the winter. Additionally, the newly formed Italian government is likely to anticipate a fiscal expansion similar to the UK, which could trigger a parallel pick-up in yields, and consequently add further volatility on the EUR side. All in all, we expect EURGBP volatilities to keep trading on high levels, and thus favour buying volatility over the near term, directionally favouring GBP.
EURGBP 1-month Implied vs Realised Volatility
EURGBP Trade Idea
Trade idea in 1-month expiry
Buy EURGBP Put, 0.865 Strike in EUR 5mio – Pay EUR 35K Circa
Sell EURGBP Call, 0.8800 Strike in EUR 5mio – Rec EUR 70K Circa
Buy EURGBP Call, 0.9000 Strike in EUR 5mio – Pay EUR 38K Circa
Total net Pay EUR 3K Circa
USDBRL NDO Positioning Data 15/09/2022 - 22/09/2022
In the week to September 29th there was a narrower range traded in the options market. Calls traded showed more upside cover to the market with options traded to 5.60. The strip of options for calls and puts are due to expire before 16th October. There were few put options traded with an expiry in October, and the majority have low notional, suggesting low conviction. There are a cluster of put options traded around 4.90 which are due to expire at the end of November.
USDBRL NDO Positioning Data 22/09/2022 - 29/09/2022
USDCNY Vanilla Positioning Data 15/09/2022 - 22/09/2022
There is little pattern to the USDCNY, but as spot rises, there is a strip of puts due to expire at the beginning of November, with different strikes ranging from 6.80 to 7.20. Before that, puts trade a range of 7.05 to 7.20. Call options executed trade a range of 7.05 to 7.30 for expiries before Mid-October. Generally, strikes continue to rise in line with spot, and while there has been a modest correction in the USD in the last few sessions, the trend will remain intact.
USDCNY Vanilla Positioning Data 22/09/2022 - 29/09/2022
EURBP Vanilla Positioning Data 29/07/2022 - 29/08/2022
There is a stark difference between the two charts below, chart 2 shows significantly more cover above 0.90 to 0.95. The calls have large notional values suggesting higher levels of conviction but also premiums have been bid due to recent volatility and spot spiking to 0.92. On the downside, there are puts traded down to 0.85 with the majority of these due to expire before 20th October. We expect spot to rally towards EURGBP due to policy risk and reduced confidence in the UK.
EURGBP Vanilla Positioning Data 29/08/2022 - 29/09/2022
Charts and Tables
Historical Spot FX Volatility (30D Rolling)
FX Matrix (today)
Key Events & Releases
JP Morgan Global FX Volatility
The index rallied in the recent weeks but has struggled to break above resistance at 13.30 and softened yesterday to 13.00. The stochastics are falling, with %K/%D diverging on the downside, which means we could see a change of trend in the near term. Likewise, the MACD diff is negative and diverging, highlighting a growing selling pressure in the near term. On the downside, a break below the near-term support of 12.50 could pave the way for 50 MA at 12.18. Alternatively, the index needs to hold above the near-term support of 13.00 before it can retarget the 13.30 level again. The recent downside is not strong enough to suggest a change of trend in the near term, despite the indicators; the key level at 13.00 has to be broken below first to confirm the downside momentum.
The index’s rally softened in the last couple of days, urging the dollar to decline back to 112.62 levels as support at 50 MA held firm. The indicators suggest further upside in the near term, with %K/%D seen converging on the upside in the oversold, and the MACD diff is negative and converging, and this helps to affirm the growing appetite for higher prices in the near term. To confirm this, the index needs to break above the 50 MA at 112.43 completely before retargeting the 114 and 114.78 highs. On the downside, a break below the 112.36 level could signal further weakness down to 100 Ma at 100.89. The indicators suggest upside momentum in the near term, and with the MA forming solid support levels, we expect the index to edge higher in the near term.
The pair has deteriorated in recent days after it had reached the highs of 0.9266, but trend support at 0.87 forced the pair to settle at 0.883. The stochastics are rising, the %K is set to cross above the %D stochastic in the oversold, a strong buy signal, and the MACD diff is negative and converging, suggesting we could see the pair push higher in the near term. The pair needs to hold above the current levels before targeting 100 MA at 0.8784 once again. The reaffirmation of near-term support at the moving averages would suggest we could see the market push higher. On the downside, confirmation of resistance of MA at 0.8844 could trigger a break of support at 0.8752 to 0.8694. The longer-term moving averages created robust support levels, and to confirm the indicators, prices need to break the resistance of 100 MA to confirm the outlook.