GBPUSD: STERLING STRENGTH MYTH? ARITCLE 50 ODDS - 50% NOT HAPPEN
Updated
Mysterious sterling strength:
1. Sterling has managed to par losses and actually rise in past days despite a number of heavily weighted factors increasing GBP downside pressure e.g. MPC M. Weale switching to the doves, PMI/ Business Optimism 8yr lows, Sterling rates markets consistently pricing >25bps of cuts to the BOE base rate (details below), the median bank forecast of the Bank of England Policy change on the 4th of August is becoming ever more dovish (e.g. calls for >£50bn QE and more than 25bps of cuts by Banks).
2. Struggling to find answers I looked at the Article 50 odds/ Implied probability from the odds aggregator (oddschecker) - to my surprise, but in support of GBP top side I have seen the market shift aggressively in the last week - with odds of a 2016 signing falling to 16.5% from 35%, but more worryingly the odds of a 2018 or later or NOT AT ALL steepening aggressively to 50% from 30%.
- 2018 or later or not at all is now the most probable outcome, worrying that this is even possible given the referendum was decided by the people in a democracy - how is this even possible? IMO it should have been mandated to be signed within a given period e.g. 1wk/ 1m.
- Even more worrying is that T. May the newly elected PM, Pre-PM was a brexit Bull and vowed that exiting the EU was her top priority and she "saw it as a way to make Britain great again". However, now if you look at the news, she is somewhat of a Brexit bear, recently stating "The Article 50 will NOT be signed in 2016" - completely writing the front end of the curve off.
3. This is likely the potential driver of sterling strength as a delayed non-signing 1) increases the time until we actually leave the EU - given there is ALREADY a clause in the article 50 agreement that states there is a 2yr "cooling off/ negotiation period" where Britain's relationship with the EU will remain exactly the same for 2yrs once the article 50 is signed - so by not signing it until mid 2017 this means technically there will be 3yrs between Brexit vote and leaving which means three years of relatively unchanged economic conditions - thus this in mind why should GBP get weaker now/ in the near-term? 2) and in turn, the above reduces BOE cutting odds - if we're not leaving any time soon the economics should be relatively flat thus no easing needed which means less GBP near-term downside.
4. Also another potential sterling topside driver is the speculation that the BOE is coming underpressure NOT to cut rates by Retail Banks as by doing so it reduces their net interest margins (lower profitability) causing restructuring/ lay-offs in the industry - LLOYDS BANKING GROUP IS AXING 3,000 JOBS AND CLOSING 200 BRANCHES AS IT RACES TO CUT COSTS IN ANTICIPATION OF AN INTEREST RATE CUT - if considered a systemic risk this could seriously reduce the probability of BOE action. Though i think it is more of a isolated issue - Lloyds likely needed to restructure anyway based on already low profitability rather than as a direct function of a potential rate cut. It is almost laughable to think 3000 jobs are being cut because of a small 25bps cut alone.
Trading implications:
1. Obviously this is a downer on GBP shorts, however, this is ONLY a suggestion for GBP strength - i could be over estimating the impact but the argument is nonetheless a solid one.
2. Still below 1.36 i stay a seller of rallies - and watch closely for the 4th of August when the BOE is expected to deliver easing which should move GBP$ to 1.25-1.28 where i will TP.
- Current implied BOE bank rate cut probabilities are priced as the following:
-Three month short sterling (GBP) rate - 66% probability of a 25bps cut, up from 64% on the 26th.
-GBP Nominal OIS Spot rate - 84% probability of a 25bps cut on the 26th, up from 76% on the 25th
-GBP 1m Fwd Nominal OIS Rate - 29bps 100% priced as of 26th, up from 26bps on the 25th.
1. Sterling has managed to par losses and actually rise in past days despite a number of heavily weighted factors increasing GBP downside pressure e.g. MPC M. Weale switching to the doves, PMI/ Business Optimism 8yr lows, Sterling rates markets consistently pricing >25bps of cuts to the BOE base rate (details below), the median bank forecast of the Bank of England Policy change on the 4th of August is becoming ever more dovish (e.g. calls for >£50bn QE and more than 25bps of cuts by Banks).
2. Struggling to find answers I looked at the Article 50 odds/ Implied probability from the odds aggregator (oddschecker) - to my surprise, but in support of GBP top side I have seen the market shift aggressively in the last week - with odds of a 2016 signing falling to 16.5% from 35%, but more worryingly the odds of a 2018 or later or NOT AT ALL steepening aggressively to 50% from 30%.
- 2018 or later or not at all is now the most probable outcome, worrying that this is even possible given the referendum was decided by the people in a democracy - how is this even possible? IMO it should have been mandated to be signed within a given period e.g. 1wk/ 1m.
- Even more worrying is that T. May the newly elected PM, Pre-PM was a brexit Bull and vowed that exiting the EU was her top priority and she "saw it as a way to make Britain great again". However, now if you look at the news, she is somewhat of a Brexit bear, recently stating "The Article 50 will NOT be signed in 2016" - completely writing the front end of the curve off.
3. This is likely the potential driver of sterling strength as a delayed non-signing 1) increases the time until we actually leave the EU - given there is ALREADY a clause in the article 50 agreement that states there is a 2yr "cooling off/ negotiation period" where Britain's relationship with the EU will remain exactly the same for 2yrs once the article 50 is signed - so by not signing it until mid 2017 this means technically there will be 3yrs between Brexit vote and leaving which means three years of relatively unchanged economic conditions - thus this in mind why should GBP get weaker now/ in the near-term? 2) and in turn, the above reduces BOE cutting odds - if we're not leaving any time soon the economics should be relatively flat thus no easing needed which means less GBP near-term downside.
4. Also another potential sterling topside driver is the speculation that the BOE is coming underpressure NOT to cut rates by Retail Banks as by doing so it reduces their net interest margins (lower profitability) causing restructuring/ lay-offs in the industry - LLOYDS BANKING GROUP IS AXING 3,000 JOBS AND CLOSING 200 BRANCHES AS IT RACES TO CUT COSTS IN ANTICIPATION OF AN INTEREST RATE CUT - if considered a systemic risk this could seriously reduce the probability of BOE action. Though i think it is more of a isolated issue - Lloyds likely needed to restructure anyway based on already low profitability rather than as a direct function of a potential rate cut. It is almost laughable to think 3000 jobs are being cut because of a small 25bps cut alone.
Trading implications:
1. Obviously this is a downer on GBP shorts, however, this is ONLY a suggestion for GBP strength - i could be over estimating the impact but the argument is nonetheless a solid one.
2. Still below 1.36 i stay a seller of rallies - and watch closely for the 4th of August when the BOE is expected to deliver easing which should move GBP$ to 1.25-1.28 where i will TP.
- Current implied BOE bank rate cut probabilities are priced as the following:
-Three month short sterling (GBP) rate - 66% probability of a 25bps cut, up from 64% on the 26th.
-GBP Nominal OIS Spot rate - 84% probability of a 25bps cut on the 26th, up from 76% on the 25th
-GBP 1m Fwd Nominal OIS Rate - 29bps 100% priced as of 26th, up from 26bps on the 25th.
Note
Raw data:bankofengland.co.uk/statistics/Pages/yieldcurve/default.aspx
Any questions please ask.
Note
Oddschecker Article 50 odds:oddschecker.com/politics/british-politics/article-50
Note
Theresa May Telling High Court not signing in 2016:theguardian.com/politics/2016/jul/19/government-awaits-first-legal-opposition-to-brexit-in-high-court
Note
* UPDATED for 27/28th July* Implied BOE Bank rate cut probabilities:
-Three month short sterling (GBP) rate - 66% probability of a 25bps cut as of 28th, stable at 66% as of the 27th.
-GBP Nominal OIS Spot rate - 92% probability of a 25bps cut as of the 27th, up from 84% on the 26th.
-GBP 1m Fwd Nominal OIS Rate - 30bps 100% priced as of 27th, up from 29bps 100% priced as of the 26th.
Note
Confidence in Central Banks:1. Following the BOJ disappointment which seems to be the norm rather than the exception of central bank delivery - Central bank confidence is likely to be taken down even lower than it already is - this could give GBP strength this week going into BOE.
- Especially so as a cut was expected in July but never materialised + MPC member K. Forbes Hawkish unwillingness to cut may resonate in peoples mind going into the meeting - I expect sterling to trade pretty flat into BOE, then sell-off quite aggressively when/ if they deliver.
Note
UPDATED ODDS:1. 14% chance of 2016, 40% 2018 or later or not at all, 60% chance 1st half of 2017
updated probabilities today - should be a bearish change for GBP, sell off in the back-end and steepening in the front-middle for H1 2017 but GBP seems to be trading bid (again).. the mystery continues.
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