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Macro and Vol Commentary

Cable has firmed in recent weeks as the UK has re-opened its economy, and cases have started to fall but can it be sustained?

Economic Data

  • UK inflation has started to rise as a result of higher input costs, CPI Y/Y was 2.5% in June, up 0.5% m/m.
    • Cost-push inflation is set to remain in the coming months, and if inflation remains above target in the medium term, questions will be asked about how accommodative monetary policy is.
    • Core CPI was 2.3% y/y in June and this was up from 2% in May.
  • ILO unemployment rate 3-months was 4.7% in May, down from 2.8%. The claimant count rate was 5.8%, down from 6% in May.
    • Average hourly earnings 3m y/y was 7.3%, up from 5.7% in April. This can be attributed to more workers coming off furlough.
    • Lower-paid employee jobs have been falling which has increased the average hourly earnings.
    • There were 862,000 vacancies in April and June was 77,500 - above pre-pandemic levels.
    • The employment rate increased to 74.8% from March to May 2021.
    • The number of under-25s on payrolls has declined by 289,000 in the last year. The unemployment rate for 16-24-year-olds stands at 13.3%.
    • We expect the unemployment rate to increase marginally in Q4 before starting to fall after the employment schemes.
  • Retail sales including fuel are up by 9.7% y/y in June, with ex-fuel sales at 7.4% y/y
    • We expect sales to improve in the near term but as the furlough scheme ends this could present headwinds to retail sales.
    • Higher prices and unemployment will be a headwind to sales in the medium term but the employment market has beaten expectations as companies are well versed in dealing with lockdowns.
  • Manufacturing PMI was 60.4 in June, as companies continued to grow. Input costs are rising and this will be a headwind to business, another key headwind is the need for workers to isolate after being pinged by the NHS app, however, settings have been changed on the app and we expect this to reduce the number of people isolating.
  • COVID-19 cases in the UK are falling, but this could be due to reduced testing. The key data is hospitalisations, and these have also started to fall, standing at 774 as of July 31st.
    • Vaccination rates are starting to improve in the younger age brackets as the Government incentivise vaccines, but also suggest full vaccine passports will be needed for nightclubs.
  • UK yields have faded in Q2 and continue to fall as the market questions the recovery, despite the economy fully open once again. We do not expect yields to change trend at this time.

MPC and BOE

  • Inflation has overshot expectations for 3 successive months now. Forecasts have underestimated the price that we have seen so far and higher inflation is happening now as opposed to Q4 when the BOE suggested it would.
  • If inflation is above the target rate and expected to remain like this, why is QE at the level it is?
  • We expect interest rates to remain constant in the near term but with a split vote on asset purchases and QE, this will pave the way for QE to start to be withdrawn in Q4, ceteris paribus.
  • However, the delta variant threat and the prospect of another wave in October may cause them to hold fire.

Federal Reserve

  • The Fed has signalled that they are also closer to tapering as the economy moves towards full employment and average inflation is above 2%.
  • Debt purchases will be first to change, from the current $120bn per month.
  • There remains an upside risk to inflation, which could prompt the market to speculate further on Fed timings.
  • Powell has indicated the mortgage-backed securities will not be reduced berore bond purchases but may decline at a faster rate once they start tapering.

Inflation is set to stay elevated in the near term, and this could prompt some tapering by officials ahead of market expectations. We do not expect interest rates to rise anytime soon but QE and asset purchases will start to fall first. The UK economy is now fully open and official data suggests cases are falling and so are hospitalisations, we do think the number of people testing and using the NHS has also declined. Input prices are high and will remain so which will fuel inflation but the demand side of the equation is muted and as unemployment edges higher after the furlough schemes come to an end, we expect demand-pull inflation to worsen. Sterling has caught a bid in recent weeks after testing 1.3571, the market needs to break above 1.40. We expect the MPC and BOE to hold rates steady but the voting could suggest tapering sooner than expected. Yields are fading and we do not expect them to catch a bid during the summer months. We favour owning cable but the dollar could strengthen in Q4 and we expect the dollar to firm in 2022.

Volatility Commentary

We’ve recently seen GBPUSD recover from the Delta Variant fuelled mid-month dip with macro FX seeing USD and JPY weakening over the last two weeks and on the GBP specific front Covid cases in the UK. We’ve generally seen in GBPUSD vols that vol has realised generally lower or roughly in line with implied. In the short term. We’re expecting both the BoE and Fed to continue loose monetary policy for the next few months in spite of inflation (with many CB chiefs taking the stance current inflation is transitory) with GBPUSD holding relatively steady following this week’s BoE. We see the potential for short term dips in GBPUSD in the event of short term Delta Variant disruptions but with the UK’s vaccination rollout going strong, recent re-openings and case numbers heading down we favour trades that benefit from GBPUSD spot heading higher.

GBPUSD 1-month Implied and Realised Volatility

GBPUSD Trade Idea

  • Buy 3-month Call option strike 1.4100, priced in 10m GBP Notional cost circa 78k GBP
  • Sell 3-month Put spread strikes 1.3750 & 1.3500 price in 10m GBP Notional per leg for circa 45k GBP
  • Total structure premium circa 33k GBP

Positioning Charts

USDBRL NDO Positioning Data 20/07/2021 - 27/07/2021

The options market saw more volume in the week to August 3rd, but the majority of trading were puts. The range of puts was relatively wide between 4.90-5.20 but the notional values are mostly small. There is one upside call which is due to expire in September with a strike at 5.45. The positioning in the near term suggests now clear change in direction but the market favours the downside. 

USDBRL NDO Positioning Data 27/07/2021 - 03/08/2021

USDCNY Vanilla Positioning Data 20/07/2021 - 27/07/2021

USDCNY Vanilla Positioning Data 27/07/2021 - 03/08/2021

Trading volumes improved this week, the trend favours the downside but options in the near term suggest some consolidation in the near term. As we move through September the market shows slightly more calls traded with strong notional values. The range in the near term is slightly narrower but as we move away from spot, the range is wider. We anticipate the market will remain on-trend in the near term but investors seem to be expecting a stable dollar in Q4.

GBPUSD Vanilla Positioning Data 03/06/2021 - 03/07/2021

GBPUSD Vanilla Positioning Data 03/07/2021 – 03/08/2021

The options market for cable has had a more lively month in the month to August 3rd, despite the summer months. The option volumes have favoured the downside with the put options spread between 1.26-1.40. There is a strong upside cover up to 1.45 but after that call option volumes thin, but there are a few up to 1.50.  This suggests we could see the market edge lower in the comings months, the 1.40 level is key as we could see some short covering if we break above this level.

Charts and Tables

FX Expiries

Volatility Grid

Historical Spot FX Volatility (30D Rolling)

FX Matrix (today)

Weekly Change

Key Events & Releases

Technical Charts

JP Morgan Global FX Volatility Index 

The index has continued to trade around the trend level, breaching the 6.80 level. The stochastics have just converged on the downside in the overbought as the MACD diff is positive and converging, suggesting we could see the index push lower in the near term. The index needs to hold above 6.80 before targeting 6.88. The reaffirmation of near term trend support and 7.00 suggests we could see the market push higher. On the downside, rejection above 6.80 could trigger a break of support back below the moving averages. A breakthrough above all moving averages suggests strong buying pressure, however, indicators point to an end of this trend; if the index holds above 6.81, then we could see prices edge higher.

Dollar Index

The dollar index has been gaining in the recent sessions, but resistance at 50 MA has proved to be strong, and the index edged lower to 92.234. The bearish candles have been less bid than recent gains, suggesting there is an appetite for higher prices above the 50 MA level. The stochastics are overbought but are seen converging, and the MACD diff positive and converging on the downside, suggesting we could see further price weakness in the near term. If weakness prevails, we could see prices break below the 92.00 level to test 38.2% fib level at 91.84 – the last week’s support. On the upside, if support above the 50 and 200 MA levels holds firm, this could trigger gains through 92.40 and target 100 MA at 92.49. The most recent candle and indicators suggest we could see the index decline in the near term.

GBPUSD

The pair has improved today after finding support at 1.3873 and closing at 1.3917. The stochastics are rising, as %K/%D just converged on the upside, which is a signal of growing buying pressure. The MACD diff is negative and converging, suggesting we could see a push higher in the near term. The index needs to hold above the 1.40 level before it could target 1.3983, the last week’s highs. On the downside, the break below the robust support level at 1.39 could pave the way for 200 MA support at 1.3838. The moving averages are edging higher, providing support on the downside, and with indicators edging higher, we expect the pair to gain ground in the near term.

Contents

Disclaimer

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COVID cases are rising across the globe as the delta variant spreads, this is causing some nervousness in financial markets, especially with the higher inflation rhetoric. Commodity prices have fallen since the Fed changed their tune inflation, the dollar has stabilised which has also been a headwind to prices. The summer months are traditionally quieter for metals demand which could prompt metals to consolidate. If the delta variant continues to spread, we may see higher levels of stimulus for longer. As things stand stimulus levels are set to be tapered and this could be brought forward if inflation remains high. We expect markets to remain volatile but on lower volume through the summer months.