Macro and Vol Commentary
As we head into the last week of April, the upcoming central bank meetings in May are once again the primary market focus. With the last 25bps of hikes pretty much priced in for Fed this year, what is the outlook for EURGBP? Will the two nations see further tightening past May?
Europe
- European sentiment improved in recent months after warmer winter months brought energy prices and, in turn, inflation expectations further down.
- Confidence in Europe continues to recover, improving by 1.6 points to -17.5 in April.
- A continued decline in energy prices brings hopes for softening inflation.
- Still, consumer confidence remains well below its long-term average, outlining a muted economic outlook for the remainder of the year.
- Moreover, Eurozone Services PMI exceeded expectations in April, increasing to 56.6 from 55.0.
- European manufacturing was considerably weaker, falling to 45.5 from 47.3 in March, way below the estimate of 48.0.
- The numbers indicated the biggest contraction in the manufacturing sector since May 2020: squeezed purchasing power, tightening financial conditions, and a shift to inventory destocking could cap manufacturing further.
- The outperformance of services relative to manufacturing was also the widest seen since 2009, pointing to an increasingly unbalanced growth.
- We expect inflationary pressures to remain high in the coming months, but price growth will plateau, supported by core performance.
- In March, annual CPI was the lowest in 13 months at 6.9% y/y, down from 8.5% in February.
- Still, underlying readings remain stubbornly high, with core inflation reaching 7.5%, driven by an increase in the price of industrial goods and services.
- Still, the ECB is committed to raising interest rates further, and markets are pricing in at least 25bps at the next meeting in May.
UK
- The UK economy faces similar challenges to the rest of Europe; however, when coupled with past events of political instability, the economy remains vulnerable to external shocks.
- UK economy managed to avoid a technical recession in Q4’22, and February performance just avoided contraction, being flat month-on-month.
- 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.
- Despite banking woes weighing on key central banks in recent weeks, inflation reading pointed to further price resilience, growing by 10.1% y/y in March.
- Core services inflation, a gauge that the BOE pays close attention to, increased to 6.6% after a dip seen at the start of the year.
- The labour market remains tight, and companies have struggled with recruitment in recent months.
- With that in mind, the BOE, which once saw few expectations of further tightening, is now expected to raise interest rates by 66pbs over the course of the year before cuts in Q4'23.
In relation to EURGBP, the key focus remains on the BOE and its divergence from the ECB when it comes to monetary policy outlook. And given the current economic background, the EU is in a slightly stronger position to continue monetary policy tightening than the UK. However, at the same time, interest rate hikes in May have now been mostly priced in, and instead, investors will pay attention to subsequent meeting guidance for June and July to help guide the pair's outlook. The higher-for-longer momentum should take some of the significance off the inflation and labour market readings to guide the central bank policy, and instead, we anticipate the market to pay attention to signs of economic slowdown. The most recent banking risks have not rocked the markets, but they have certainly brought the recessionary risks further forward in the year. Lingering political uncertainty is also adding pressure on GBP, and we expect the pair to drift higher to 0.8900 and 0.8980, respectively (2 months).
Sources: S&P Global, Bank of England, UK Office for National Statistics, Eurostat
Volatility Commentary
EURGBP has been trading in a range, but with upcoming Central Bank meetings in UK and Europe in early May, we expect these ranges to be tested. In the short run, both central banks are likely to continue monetary tightening; In the UK rates are likely to rise by 25 basis point as inflation remains stubbornly elevated, whilst in Europe possibility of 50 basis point hike in May still on the table and will largely be determined by inflation data prior to the meeting.
Despite historical vol realising below Implied over the last month, 1M Implied Vol in EURGBP are now at their lowest levels since Jan 2022. Hence, long vol Strat would be our recommendation. Given our view on the Cross a long Iron Condor would be our strategy of choice.
EURGBP 1-month Implied vs Realised Volatility
EURGBP Trade Idea
- Long Iron condor
- Buy 1month EURGBP Vanilla Put @ strike 0.88 and Call @ strike 0.89
- Sell 1month EURGBP Vanilla Put @ strike 0.855 and Call @ strike 0.915
- 10m Euro Notional on each leg
- Net structure costs 63K GBP - spot ref 0.885
- Max payoff (250K GBP - Premium Paid)
- Max Loss ( Premium Paid)
Positioning Charts
USDBRL NDO Positioning Data 13/04/2023 - 20/04/2023
USDBRL expiries saw the number of options fall in the week ending April 20th, as investors reduced the number of put options for front-month expiries. The range remained unchanged at the same time, suggesting that downside momentum is waning and the cover is diminishing. At the same time, the near-term expiry range narrowed, suggesting investors are comfortable at current levels. We expect options to edge marginally upside in the near term.
USDBRL NDO Positioning Data 20/04/2023 - 27/04/2023
USDCNY Vanilla Positioning Data 13/04/2023 - 20/04/2023
USDCNY option saw downside cover diminish in the week expiring on April 20th, with the number and size of upside cover growing. This suggests a growing upside momentum in the near term. In particular, the size and number of call options are getting bigger for expiries taking place further down the curve, pointing to a growing conviction for higher prices.
USDCNY Vanilla Positioning Data 20/04/2023 - 27/04/2023
EURGBP Vanilla Positioning Data 27/02/2023 -27/03/2023
EURGBP options expiries widened slightly in the month ending April 27th; however, the near-term range remained tight, suggesting the market is comfortable at current levels. The number of call expiries has diminished, but a great size suggests a strong conviction for higher levels. However, the downside cover remains tight, suggesting support at current levels remains robust. We expect the appetite on the upside to grow in the near term.
EURGBP Vanilla Positioning Data 27/03/2023 - 27/04/2023
Charts and Tables
FX Expiries
Historical Spot FX Volatility (30D Rolling)
FX Matrix (today)
Weekly Change
Key Events & Releases
Technical Charts
JP Morgan Global FX Volatility
The index found some upside momentum in recent days, breaking above the resistance of 50 MA at 9.16 after support at 9.00 held firm. At the same time, a breach of a shorter-term moving average highlights the recent upside conviction, and we could see futures test the 100 MA in the near term. The indicators, however, point to the index being heavily oversold, and with %K/%D now flattening out on the downside, suggesting we could see further gains before momentum changes. The MACD confirms this, as it is positive and converging. To confirm the acceleration of the downside trend, the index needs to confirm the resistance at 100 MA at 9.57 before falling back below 50 Ma to 9.00. Alternatively, if the index was to find support at current levels, we could see the index retest the 100 MA. The indicators point to a growing of downside momentum in the near term; with them being oversold, we expect upside appetite to slow.
Dollar Index
The index found support at 100.82 recently and has traded slightly above it since then. The upside momentum, however, was capped by short-term term moving averages, causing the index to trade sideways, slightly below the 102 area. The indicators point to a slowing downside momentum: the %K/%D is seen converging on the upside. The MACD diff is negative and converging marginally on the upside, suggesting a lacklustre appetite for slightly higher levels. To suggest the acceleration of that momentum, the index first needs to break above the 50 and 100 MA levels at 101.75. A break above this level could signal further upside to 102 and 102.43, the 200 MA. Alternatively, if trend resistance holds, a breach of 101 could set the scene back to 10.82, the recent support level. We expect some moderate upside in the near term but for the moving averages to cap any strong momentum.
EURGBP
The pair found support above the trend line in recent days, forming an ascending triangle formation. This suggests that this resistance level is holding firm, but the pair continues to test this level as appetite remains on the upside. The indicators confirm this, with %K/%D diverging on the upside out of the oversold, and the MACD diff is positive, but the upside moves have been lacklustre. To confirm the acceleration of trend, the pair needs to break above the robust 0.8876 level before 0.89. Alternatively, if moving average levels do not hold, we could see the pair test the 0.8815 level once again. The indicators point to continued upward momentum in the near term, and to confirm this, the pair needs to break above the resistance at 0.8876 first.
