Macro and Vol Commentary
EURGBP remained range-bound in February, fluctuating between the gains and losses of 0.898 and 0.875, respectively. With key central bank meetings taking place next week, what is the outlook for the key European currencies in the near term?
- UK economy managed to avoid a technical recession in Q4'22, and January performance surprised on the upside, growing by 0.3%.
- The economic outlook improved slightly in recent weeks on the back of recent reductions in mortgage rates, improving consumer confidence, and continuing resilience in the labour market.
- Still, IMF predicts that the UK will go into recession in 2023, while every other major economy will avoid that, given the country's high exposure to natural gas and higher prices being passed down to consumers.
- We expect the underlying activity to continue on a general downward trend throughout the year, driven by deteriorating consumer demand in the face of elevated inflation.
- Labour market remains tight, and companies have struggled with recruitment in recent months
- The unemployment rate is at 3.7%, a historic low, and this could provide another boost to wage increases as companies try to attract employees.
- Inflation came in lower than expected in January, at 10.1% y/y.
- Core service inflation, a gauge that the BOE pays close attention to, softened below 6.0% y/y for the first time since June.
- UK inflation path is behind that of the US, and we expect to see further easing before the reading finds support above the core level, which will add to the price stickiness.
- Key market focus has been on the BOE and its divergence from other central banks when it comes to monetary policy outlook.
- The CB hinted that it stands ready to pause hikes, suggesting that a 25bps increase in March increase to be the last.
- This is further supported by the BOE's belief that firms will raise prices and wages less aggressively, with wage growth expectations now at 5.7%, down from 6.3% in December.
- At the same time, interest rate cuts have now been mostly priced out this year, and instead, traders have bolstered their bets for a higher peak at above 4.75% by the end of the year.
- We anticipate another 25bps hike in March, followed by a pause in rates, keeping higher terminal rate for longer into the new year.
Europe and the ECB
- In line with the UK, confidence in Europe improved across the board in January.
- The European Commission is now stating that a recession in 2023 is possible to avoid, given falling natural gas prices and supportive government policy.
- Still, we believe that the markets are calling a victory on recession too early, and we are likely to see the bloc's GDP underperform in comparison to the Western counterparts.
- The most recent CPI figure pointed to a shallower-than-expected decline in inflationary pressures in January, with the level falling back to 8.6%.
- At the same time, core inflation continues to trace higher, reaching record levels of 5.6%, and is yet to show signs of softening.
- We do not expect CPI softness to be smooth, especially in Q1 2023.
- With that in mind, the ECB is set to continue on a path of tightening, given how behind the curve it is, and at a faster rate than the US and the UK, with forward swaps currently pricing in a 50bps hike in a week and 43bps in May.
Our outlook for EURGBP is that of marginal strength. We underpin this by the divergence in monetary policy moves between the two central banks, with ECB set to hike further given it is behind the curve. This is further supported by the latest round of inflation releases, with the European price softness being shallower than expected, giving more room for monetary policy tightening in the region. We expect EUR to be more supported, giving room for thevEURGBP currency pair to trade within 0.87-0.9 (1 month). Lingering political uncertainty is also adding pressure on GBP, and while the new deal with the EU is set to remove some frictions in relation to Northern Ireland, it is unlikely that it will make any material difference to the wider economic outlook. In the longer term, neither of the CBs is expected to pivot until early next year, and we expect EURGBP to trade sideways around 0.67.
Sources: S&P Global, UK Office for National Statistics, Eurostat, European Central Bank
EURGBP has experienced a decrease in realised volatility across 4 months by order of 3-4 VOLS. Implied Volatility on the other hand has been range bound with no significant changes, however we do believe that this could potentially change as ECB has signalled that they are adopting a tighter monetary policy while BOE has shifted their sentiment and diverged to a less tightening policy. Furthermore looking at the options term structure, we see an inversion in the 1 month ATM implied volatility surface, signalling that the market is currently under pricing volatility, given this we believe this is a good opportunity to be long volatility. We suggest a call ratio spread to capture to gain upside exposure while limiting downside risk.
EURGBP 1-month Implied vs Realised Volatility
EURGBP Trade Idea
1 month expiry
Buy EURGBP Call, 0.889 Strike in EUR 3mio – Pay EUR 25K CIRCA spot ref 0.88937
Sell EURGBP Call, 0.887 Strike in EUR 1mio Rec EUR 9.6K CIRCA spot ref 0.88937
Total Net Pay 16k CIRCA
USDBRL NDO Positioning Data 23/02/2023 - 02/03/2023
USDBRL expiry data pointed to a continuation of diminishing appetite, with the size of notional positions decreasing in the week ending March 9th. At the At same time, the near-term expiries are now centred tightly around 5.10-5.30 area; this, combined with smaller size of both puts and calls, suggests waning market appetite for prices out of this range. In the last week of March, however, we see appetite improve drastically, with some calls above 5.30. There are also accompanied by larger puts at 4.90-5.00. We expect the pair to remain range-bound in the near term, as a result.
USDBRL NDO Positioning Data 02/03/2023 - 09/03/2023
USDCNY Vanilla Positioning Data 23/02/2023 - 02/03/2023
USDCNY options expiring in the week ending March 9th pointed to a slightly tighter range , with next week's calls and puts ranging between 6.85-7.00, vs 6.80-7.10 for the options expiring in the week ending March 2nd. At the same time, the number of puts has reduced, adding to smaller downside cover, while the upside cover remained unchanged. This highlights that while appetite for higher prices remains unchanged, bears have scaled back and moved their positions. In particular, we see building appetite for puts in the first week of April. We expect some upside in the near term, before a slight momentum shift in early April.
USDCNY Vanilla Positioning Data 02/03/2023 - 09/03/2023
EURGBP Vanilla Positioning Data 09/01/2023 - 09/02/2023
EURGBP range moved sharply to the left in the month ending March 9th, with trading concentrated at 0.9-0.95. This suggests a stronger conviction for prices at these levels in comparison to expiries ending in the month of February 9th. At the same time, the number of options reduced, while the size increased, highlighting the growing certainty for these levels. There are a few large calls expiring in November, but the outlook for March and April looks mostly range bound.
EURGBP Vanilla Positioning Data 09/02/2023 - 09/03/2023
Charts and Tables
Historical Spot FX Volatility (30D Rolling)
FX Matrix (today)
Key Events & Releases
JP Morgan Global FX Volatility
The index weakened sharply today after rejecting resistance at the 100 moving average level to now settling at 9.79. The index found support at this level today. The stochastics are continuing to fall, and momentum is seen on the downside in the near term. The %K/%D is falling into oversold, and the MACD diff is negative and diverging sharply, given today’s move. The moving average levels are now providing robust resistance levels on the upside once again, and the index would first need to break above these levels before testing 10.40. Alternatively, appetite below current levels could set the scene for 9.60 and 9.34 in the longer term, marking December lows. We expect some downside in the near term, but for the index to struggle below the 9.79 level.
The index jumped higher in recent days, but resistance at 105.88 held firm, and now the index is below the 105.30 level at 105.23. The indicators point to a waning downside momentum, with %/K%D converging on the upside in oversold, and the MACD diff is negative but flat, highlighting the slowing appetite for lower levels. To confirm the acceleration of the upside trend, the index needs to break above the support of 105.35 before testing 105.88 once again. Alternatively, if the index was to break below the 50 MA level at 104.91, we could see levels test 100 MA at 104.02 and then 104 once again. The indicators point to a slowdown of downside momentum in the near term, and we expect to see prices breach 105.35, following the longer-term trend.
The pair has weakened sharply today, testing support at 0.8892, and has rebounded slightly since then to trade at 0.8841. Still, the pair remains supported by the longer-term trend level. Today’s candles rebounding near this level confirms that the level remains firm. The indicators point to a growing trend on the upside, as stochastics are converging on the upside in oversold, and the MACD diff is negative, but the pace of the decline is slowing. The next robust level on the upside are at the moving average levels at 0.8850, and if the pair breaks above them, we could see future gains to 0.8881. On the downside, if the 61.8% fib level at 0.882 is broken, this could suggest further impetus to 0.8800. We expect EURGBP to rebound slightly and continue on upward momentum in the near term.