Macro and Vol Commentary
Risk appetite for cable is dwindling, but what is next for pair as cases start to increase?
UK data: missing the point
- Q1 GDP was weaker than expectations, declining by 2.2% q/q and 1.7% y/y. This paints a very bleak picture for Q2, which saw the brunt of the lockdown. Estimates for 2020 as a whole suggest that the UK economy will contract 8-10%
- Three-month rolling GDP from the Office of National statistics outlines a decline of 10.4% to April (Feb-Apr). We expect investors to look through this data to some extent, but this outlines the weakness of the UK economy going into leaving the EU and potentially facing a second wave
- Accommodation and food services declined the most by -40.9%
- Construction -18.2%
- Education was -18.8%
- Transport and storage -18.3%
- Private consumption for Q3 was -2.9% q/q, general government consumption expenditure was -4.1% q/q, down from 1.5% in Q4 2019
- Trade saw a fall from -10.8% in Q4 2019 to 13.5% in Q1; not as poor as some expected. Imports declined to 9.4% for Q1, from 5.3% in Q4 2019
- The current account balance fell to -£21.1bn, we expect this to deteriorate in Q2 as exports grind to a halt
- Mortgage approvals have weakened as well to 9.3k in May; we expect credit conditions to remain tight in the near term as banks remain cautious despite expansive stimulus from the government and BOE
- The claimant count unemployment rate has increased to 7.8%, and we expect this to continue to rise, exerting downward pressure on mortgage approvals, consumer consumption and inflation
- Monthly jobless claims did fall from 1,032,700 in April to 528,900 claims in May
- The furlough scheme has helped support the economy and will continue to do so; the savings ratio has increased in Q1 to 8.6% from 6.6% in Q4 2019
- Estimates suggest that 25% of furloughed employees will be made redundant
- Manufacturing production declined in April by 28.5% y/y and 24.3% m/m, down from 9.7% y/y and 4.6% m/m respectively
- Industrial production also weakened in April to 24.4% y/y and 20.3% m/m. We expect both industrial and manufacturing production to improve in May as lockdown restrictions started to ease
BOE and Government Stimulus
- Public sector net cash requirement in May remained elevated in May at £71.436bn, marginally lower than £73.937bn in April
- Net borrowing increased to £54.49bn in May from £47.774bn in April. March was £6.851bn for context
- Public sector net debt as a % of GDP was 116.6% in May, up from 109.2% in March
- The Gov’t budget balance as % of GDP was -2.56% for Q1; we expect this to rise in Q2
- The PM outlined a new £5bn infrastructure spending on the UK
- The BOE has kept their base rate at 0.1%, and the 10-year yield is 0.17%
- The BOE voted to increase asset purchase target by 100bn, with the program ending by year-end
- Stimulus may be amended in months to come be seems sufficient at this time; we believe they would prefer to use QE than cut IR
- Negative rates would be a headwind to the UK’s banking system
Economic data is starting to improve on a month-on-month basis, similar to most economies. The threat of a second wave is rising, exemplified by the increase in restrictions to Leicester and other regions in London. As bars and restaurants open this weekend, and an estimated £210m to be spent this weekend alone, this will help employment and the economy but threatens another wave of virus spread. Stimulus measures remain accommodative, and we listen to announcements in the coming months, but debt levels are rising, which will remain a constraint the economy in the longer run. Positioning for GBP remains short, and the EU-UK negations and COVID related developments continue to drive positioning and moves. There is evidence to suggest data is improving but the risk of a second wave needs to be prevented in conjunction with a deal with the EU for cable to break above recent highs with conviction.
The UK is currently in its reopening phase, with PM Johnson intending to roll out a recovery plan, evoking FDRs “New Deal” as the UK seems well past the peak, and GBPUSD vols well away from the March spike. We do still see GBPUSD implied vols higher than the start of the year (see below graph); however, this is common across most FX Macro vols. We also note that current GBPUSD vol levels aren’t out of the ordinary compared to 2019, bearing in mind Brexit risk being in play over the last year and a deal between the UK & EU still not agreed upon. There is a potential of a no-deal outcome at the end of the UK-EU transition period (31/12/2020). With the UK gradually opening up, we expect to see over the shorter term moderate strengthening of GBP. Though given there may be road bumps, to the UK recovery if local lockdowns (such as Leicester’s) keep popping up and the uncertainty around EU-UK negotiations, we favour being slightly long vol/gamma and favour holding some downside for the end of the year/start of next year.
GBPUSD Trade Idea
- Long vol/gamma trade that benefits from a medium-term rise in GBPUSD and offers downside benefit longer-term
- Priced in 10m GBP Notional with just over 6-month expiry (06/01/2021)
- Buy KI Put option with strike 1.2400 (slightly ITM at time of writing) and barrier 1.2600 for premium circa 168k GBP
- For reference, the vanilla equivalent has a cost of circa 261k GBP
Tables and Charts
JP Morgan Global FX Volatility Index
The index has edged lower this week, breaking below the 100 DMA at 8.46. The stochastics are falling further into oversold territory and the MACD diff is negative and diverges on the downside. The breakthrough the 100 DMA and the bearish engulfing candle suggests lower prices in the near term. Support stands at 8.20 in the immediate term before the longer-term downside target of 7.50. On the upside, the index needs to regain a footing above the 100 DMA and then the target trend resistance at 8.70. The index has failed into this level in recent weeks keeping momentum on the downside. We anticipate prices to remain on the back foot and for any rally to be sold into.
The dollar index has continued to fail into the 61.8% fib level and as the stochastics and MACD diff suggest lower prices, we could see breakthrough support at the 100 DMA at 98.107 to 96.430. This level held strong last week but the rejection of higher prices and the bearish engulfing candle suggests selling pressure is strong. On the upside, if support at the 100 DMA holds firm this could trigger gains towards the 61.8% fib level. In order to regain upside conviction, the index needs to gain a footing above the 200 DMA and the 61.8% % fib level towards 100.657.
Cable has softened in recent weeks after failing above 1.28. The indicators are positive and suggest higher prices in the near term as the stochastics are oversold and the MACD diff is positive and diverges. Near term, trend support has held firm in recent weeks and this has prompted a lower low environment. Repeated rejection of higher prices and trend resistance could trigger losses through support at 1.2306 at the 50% fib level before the recent low at 1.2252. On the upside to confirm the three white soldiers and bullish engulfing candle, cable needs to break trend resistance and then the 100 DMA at 1.2494.