Macro and Vol Commentary
Trade Negotiations between the EU and UK are continuing, will a deal be agreed? This week we give a brief summary of recent developments.
- Negotiations have intensified this month as the two sides have failed to agree a deal. This was after the European Council in October, when no agreement was struck. The EU called for the UK to make necessary moves to make an agreement possible, and suggested the UK negotiators ‘work on their preparedness and readiness at all levels and for all outcomes, including that of a no agreement’
- Talks are set to miss this weekend's (14/15th November 2020) and extend into next week. The days to approve and ratify the deal are running out as this process needs to happen before their last plenary session on December 14th. In practice you would expect extra parliamentary sessions to push through adeal
- The transition period will end on December 31st 2020, and as while the UK believe no deal is better than a bad deal, this is not the case
- Failure to achieve a free-trade agreement would add insult to injury during to the UK economy as we head into another lockdown
- Businesses and the economy cannot afford a no deal after the how they have been hammered by COVID-19
- There is significant risk to UK borders & customs, security system, trade, judiciary system
- According to the British Freight and Transport Association has estimate that for every extra minute a lorry spends are the UK border for customs checks, will mean an extra 30km of queues at roads to Dover
- Michael Gove, has indicated that delays could be 2 days, Just in Time business will struggle the most, especially after we have seen delays due to COVID-19.
- Agricultural products which are highly perishable are likely to be most impacted
- There are 7 principles for the negotiations, the most important is the final one, ‘It is understood that, regardless of progress in individual workstreams, nothing is agreed in these negotiations until a final overall agreement is reached.’ (European Commission)
- One of the major obstacles to a deal has been access to UK fishing waters, however, some reports that a solution is on the horizon. The solution would mean the UK would be able to say have won back control of the waters, and for fisherman to increase their catch. Quotas would be used, but the decision regarding EU boat access/allocations would be delayed
- Overfishing has been a significant problem over the years, causing a significant decrease in the total fish stock. As a result fishing makes up a less than 1% of UK GDP
- The UK are a net importer of around 270,000 tonnes worth £1.5bn
- In 2019, the UK had the second largest total catch and 2nd largest fleet size in gross tonnage in the EU
- In order to preserve the UK fishing industry and jobs in the long run, the government need to find a way to achieve a maximum sustainable yield, while subsidies may be necessary, the government needs to prevent overfishing
- The UK has already published a tariff schedule if a deal is no agreed, these will come into effect on January 1st. Some tariffs will be kept at 0 but some are very high for example some dairy products are 150%
There is clearly significant downside risk for the UK economy as a result of a no deal Brexit, considering the economy is in the worst recessions on record, a no deal Brexit is not an option. We expect a deal but as we know 2020 has consistently surprised to the downside. This will keep Cable, EURGBP, and EURUSD volatile in the next few months and in H1 2021. As the UK heads into another lockdown, headwinds are still mounting against sterling in the near term, even if we get a deal. Macro data will deteriorate in November and December, therefore Q4 as well. We favour owning cable below 1.26, and GBPEUR below 1.08 as a long term trade after vaccine sentiment subsides, GBPJPY is preferred as a hedge, however, given volatility options provide a better option as highlighted below.
With the US election priced out and Joe Biden projected to be the President elect we’ve seen Macro Vols come with GBP pair vols being no exception, however with the UK’s post Brexit negotiations still in play we still see elevated GBP vols. As we’ve approach the end of the UK’s transition period with the EU we’ve seen this priced in, looking at the 3 month expiry GBPUSD vol compared to other major vols such as EURUSD and USDJPY we can see as the end of the transition period gets priced into the 3 month expiry/calendar we see a sharp jump in GBPUSD vols in comparison to other major pair vols. Unlike the US election or original referendum there’s no clear date when the negotiations are likely to end and when the final decision on deal or no-deal will be made (with previous deadline dates having been delayed or overrun so far anyway) so unsurprisingly short date vols remain elevated and we see noticeable inversion of the vol curve which we expect to stay likely till year end and into the early parts of next calendar year unless a deal is a reached.
GBPUSD, EURUSD, USDJPY 3-month Volatility
In Chart 2 options executed are more sporadic and have a wider range, with the majority of options executed in a 0.85-1.00 range. In the Chart 2 put option volumes were higher and had a more concentrated range compared to the calls. While we saw some calls executed around 1.00, the majority were around 0.95. In Chart 1 the range was higher with a lot less upside cover suggesting downside sentiment. The majority of options were executed between 0.85-0.93 and now we are seeing spot weaken towards 0.88 traders look to be in the money. Option execution and spot suggests we could see further losses in EURGBP in the near term but volimes in the first chart were lower.
EURGBP Vanilla Options >35m Notional - 11/10/2020 to 11/11/2020
EURGBP Vanilla Options >35m Notional - 11/09/2020 to 11/10/2020
USDBRL NDO >10m Notional Value 04/11/20 - 11/11/2020
This weeks options shows a moderate downside bias, however the options executed with large nationals are not due to expire until December. The range of options executed is very wide at 5-6, but there are few options for expiry in October. We expect the market to remain in the recent 5-5.50 range but December options suggest spot could move towards 5.
USDCNY Vanilla Options >30m Notional Value 04/11/20 - 11/11/2020
Options executed this week show a downside bias, with greater amount of put options and some downside exposure below 6.50, with some expiries at February 23rd 2021. Upside call volumes have been think with little cover abvoe 7. The option market is indicating that spot will fall in the near term.
Charts and Tables
Historical Spot FX Volatility (30D Rolling)
FX Matrix (today)
Key Events & Releases
JP Morgan Global FX Volatility Index
The index has weakened recent after the failing to gain a footing above resistance at 9. The index broke through support levels at the 100 ad 200 DMA, prompting a test of support at 8. The stochastics are falling and are oversold as the MACD diff is positive and diverge on the upside indicating improved sentiment on the upside. In order to regain upside conviction, the index needs to gain a footing above 8.50 and then target 8.75 at the 200 DMA. Conversely, the full candles on the downside an bearish engulfing candle suggests lower prices in the near term, through support at 8. Despite the MACD diff showing signs of improvement, and we expect the index to improve in the near term.
The index has strengthened in recent sessions after finding support at 92.130, prompting a break back above previous trend resistance and now challenges the 50DMA at 93.176. The stochastics are rising to overbought and the MACD diff is diverging on the upside suggesting higher prices in the near term. The bullish candles and indicators could see the market challenge the 200 DMA at 93.410 before targeting the recent high around 94. However, the long term trend since September has been lower with lower highs and lower lows, if the band of resistance between the 200 DMA and 94 hold firm, this could trigger losses back to 92.50. In order to confirm the downward trend, the index needs to take out support at 92.130 and 92. Near term momentum is on the upside but the rejection of the 50 DMA
We have seen an increase in selling momentum in recent sessions, prompting a test of the lower trend channel. The MACD diff is negative but has started to converge as the stochastics and RSI are both oversold but also show moderate signs of strength. To confirm the rejection of prices at the 200 DMA, prices need to break below the lower trend channel and support at 0.88662. Superseding this level, support stands at 0.8800. Conversely, appetite for prices at 0.88662 could set the scene for higher prices back to 0.89579, with the 50 DMA at 0.89915. The moving averages are falling and selling pressure has been strong, we expect this to remain the case, with rallies being sold.