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Macro and Vol Commentary

Sterling has been resilient despite the political and economic risk; the news that Scotland wants a new independence vote has not impacted the currency, but what is the road ahead?

Economic Data

  • Inflationary pressures are integral to the U.K.’s economic growth; projections suggest that CPI will reach 11% in Q4. PPI reached 22.1% Y/Y NSA in May, up from a revised 20.9%.
    • Higher energy and food costs will continue to impact consumer finances in the medium and longer-term, especially when you factor in low energy inventories ahead of the winter.
    • Food prices are higher on the year but have corrected to the downside in the near term. This will alleviate the market pressures, but nothing substantial has changed, and higher rates will not impact the war.
    • Supply chains are easing, which will reduce inflationary pressures, and the shipping industry is suggesting that demand is poor, in line with CBs hope that high inflation is the cure for high inflation.
  • PMIs are still expansionary, and we saw services and composite PMIs increase in June to 53.4 and 53.1, respectively.
    • Services PMI was boosted by consumer spending, but this is expected to decline as respondents reference high cost of living and economic uncertainty.
    • Employment is still strong and growing, but costs are higher due to salaries and prices of goods.
    • Manufacturing PMIs reached the lowest level in 23 months; similar forces were at play to the services PMI. Staffing was stronger, but business confidence for the next 12 months was the lowest since the start of the pandemic.
  • GDP data for Q1 came in at 0.8% Q/Q, but we expect this figure to fall for Q1 as costs climb and private consumption edges lower. However, as mentioned, the services, manufacturing, and composite PMIs are still expansionary.
    • Monthly GDP slowed to 0.1% in March and 0.3% in April, and it is expected to fall by 0.3% in Q1, with May’s GDP at 0.1%.
  • Private consumption is expected to be 0.6% Q/Q for Q1, but imports are still expected to be strong at 9.3% Q/Q, which could show a robust demand outlook. Once again, this figure has a downside in Q2 and the remainder of 2022.
    • A key data point is net consumer credit which we expect to rise 5.5% Y/Y in May. The cost-of-living crisis will see consumers increase credit card activity; CAB data indicated that consumers were using credit cards to pay buy-now-pay-later balances.
  • The employment sector is strong, and this buys the BOE some time in their tightening monetary policy. The claimant count rate stands at 4% as of May, and the ILO unemployment rate is 3.8%.
    • Vacancies reached 1.3m in the months to May, broadly in line with the stock of the unemployed.
    • BOE Governor Andrew Bailey has indicated that wage rises should reflect productivity gains, and there is no one number on wage increases across the country.
  • The U.K. economy is weakening, but consumption is still robust despite higher prices. This will change in Q4 as consumers prepare for winter, with energy costs expected to worsen.

Central Bank

  • The weakness in sterling and strong imports will push inflation higher, and Catherine Mann of the MPC has indicated that a more robust policy move reduces the risk of inflation being further boosted.
  • Chief Economist Hew Pill has indicated that the MPC may need to act further. He noted that if current inflation becomes embedded in pricing behaviour and wages, that will trigger higher rates.
  • The door is open to higher interest rate hikes in the next meeting. The market probability of a rate hike is 188%, with an implied rate of 1.66%. The next four meetings have a rate hike probability of over 100%, and the December futures rate was 2.75%, but the implied rate based on the overnight index swaps is 2.85%.
  • In the last meeting, three members preferred a 50bp rate hike, but six voted in favour of a 25bp hike.
  • The door is open to higher a 50bp rate hike, and the strong labour market suggests at this time, the economy can withstand it. However, we expect downside rate hikes in Q4 as economic data deteriorates.

Both central banks are raising rates steadily, but the U.S. economy is more isolated from the energy crisis than Europe and the U.K. However, their consumer is in better shape, suggesting a recession will be shallower in the U.S. Traditionally, a U.S. recession doesn’t last as long as in Europe and the U.K., an energy crisis will keep inflation high, but this does not necessarily mean a deep recession. Higher rates in the U.S. strengthened the USD, but now investors are looking at growth projections and consumer spending; the U.S. is stronger than the U.K. in this respect. Both housing markets have maintained strength, but mortgage rates in the U.S. are higher and rising in the U.S.. Stagflation is now a base case and expect less of a shock in the U.S. due to their energy supply. The crisis in Ukraine will keep food prices higher in the medium to long term, but supply chains will ease in 2023. We expect further downside to sterling in the near term and this weakness to prevail. Political risk has subsided in the U.K., but this is prevalent, especially as Boris Johnson won his no-confidence vote by less than Theresa May, and she left office within the year. How Boris Johnson deals with the cost-of-living crisis is integral, especially after losing two key seats in the by-elections. President Biden is looking to win votes ahead of the mid-terms, but Trump’s hearing could also damage the republicans; again, it will come down to the cost of living. We expect cable to break below 1.20 and favour owning USD against sterling, but we see a downside to rate hikes in Q4 due to economic data when political risk is a factor.

(Sources: BOE, S&P Global, UK Office for National Statistics)

Volatility Commentary

Inflationary pressures, concerns over GBP’s monetary policy effectiveness and questions around political stability have recently contributed to the fall of GBP vs USD. This materialised into a significant pick-up in options’ volatility, particularly on the front-end. In fact, the absolute 1-month spread between realised and implied volatility is now trading at 3.75%, up from 2.2% circa when compared to the beginning of May. We still see downside on GBPUSD, as economic growth and rates concerns weigh down on GBP, and thus favour buying volatility over the short-term, with a downward directional view.

GBPUSD 1-month Realised and Implied Volatility

GBPUSD Trade Idea

  • Trade idea in 1 month expiry
  • Buy EKI GBPUSD Put, EKI level 1.195, Strike 1.22 in GBP 5mio – Pay GBP 70K Circa
  • Sell GBPUSD Call, Strike 1.245 in GBO 5mio – Rec GBP 15K Circa
  • Total structure premium net Pay GBP 55K

Positioning Charts

USDBRL NDO Positioning Data 16/06/2022 - 23/06/2022

The options market shifted to a higher range in the week to June 30th but trades still show a preference to the downside. Put options trade a wider range but the expiry for these options are in August. The put options have a higher notional value, call options traded a wider range between 5.20-5.60 with one option at 6. The volumes traded are higher in the week to June 30th. 

USDBRL NDO Positioning Data 23/06/2022 - 30/06/2022

USDCNY Vanilla Positioning Data 16/05/2022 - 23/06/2022

Options traded around 6.70 with a significantly tighter range than the week prior. Volumes in chart 2 below highlight that there the market expect prices spot to continue to rally with calls trading up to 7.10 but the put range only between 6.50-6.70. Traders have less of view in the longer run with fewer options trading after September, and those options that were traded have a low notional value. 

USDCNY Vanilla Positioning Data 23/06/2022 - 30/06/2022

GBPUSD Vanilla Positioning Data 30/04/2022 - 30/05/2022

Options traded in June showed more favourability towards the downside. The range and volume for call options was lower than the previous month, call options traded to 1.32 with one call at the beginning of July trading above 1.35. Put volumes increased and traded to a lower range to 1.10 out to the end of August, after October there is little view but we expect the mid-terms to skew data around that time. We expect options to favour the downside as spot drifts. 

GBPUSD Vanilla Positioning Data 30/05/2022 - 30/06/2022

Charts and Tables

FX Expiries

Volatility Grid

Historical Spot FX Volatility (30D Rolling)

FX Matrix (today)

Weekly Change

Key Events & Releases

Technical Analysis

JP Morgan Global FX Volatility 

 

The index has gained ground in recent days, breaching 11.00 levels to trade at 11.47. The stochastics are edging higher in the overbought, although showing signs that both can converge in the near term. The MACD diff is positive and flat, signalling stalling upside momentum and a possible change of trend in the near term. The gains have been well bid, and the most recent candles broke above the moving averages, indicating momentum is still on the upside. If support at these levels holds firm, it could trigger gains back to 11.50 before 11.90 – the recent highs. On the downside, if support at 100 MA at 11.1563 is broken, we could see the index edge lower through the 50 MA level at 11.00 and, consequently, the 10.65 level. The indicators and support at 100 MA highlight recent strength, but momentum could be fading in the near term. 

Dollar Index 

 

The index was well bid, and this triggered gains through all moving averages last week, but resistance at 105.62 held firm once again, and the index softened into 104.84. The stochastics have converged on the downside and are now falling, and the MACD diff is negative and diverging, suggesting growing selling pressures. The reaffirmation of resistance at 105 could trigger a break below the 50, and 100 MAs at 104.50 would help to confirm the double top formation. Conversely, a breach of resistance at 105 may prompt the bulls to target 105.62, the recent highs. The most recent gains have been strong, but the near-term resistance has proven to be robust, and we expect the index to remain under the level. 

GBPUSD

 

The pair has improved today after finding support at 1.1976 once again and closing at 1.2155. The stochastics are rising, as %K/%D is about to enter the overbought, which is a signal of growing buying pressure. The MACD diff is positive and diverging, suggesting we could see a push higher in the near term. The pair needs to hold above the 1.21 level before it could target 50 and 100 MAs at 1.22. On the downside, the break below the robust support level at 1.20 could pave the way for 1.1976, where a recent double bottom formation has been formed. The moving averages are edging lower, providing resistance on the upside, and with indicators edging higher, we expect the pair to gain ground in the near term before continuing the descending triangle formation in the longer-term trend.

Contents

Disclaimer

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