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OIS
GBPUSD: STERLING STRENGTH MYTH? ARITCLE 50 ODDS - 50% NOT HAPPENMysterious 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.
GBPUSD SHORT: BOE/ FOMC POLICY EXPECTATIONS INCREASINGLY BEARISHFollowing today's Service/ Manufacturing PMI miss (worst contraction in 88 months - since 2009) the Sterling market has come under significant pressure as BOE rate cut expectations increase with OIS rates markets pricing a 94% chance of a 4th Aug cut vs 85% before the PMI's were released.
Further, the PMI misses has attracted attention from UK Politicians e.g. Chancellor Hammond - which puts further qualitative pressure on the BOE to cut, rather than just quantitative data prints - Political pressure combined with data pressure is the best us GBP sellers can ask for when looking for a BOE rate cut.
I have to say this is a breath of fresh air for GBPUSD shorts that i am holding (cable trades down to 1.30xx) - given that the start of the week was the complete opposite, with strong CPI/ Employment and Hawkish comments from MPC members Weale and Forbes; all of which reducing the pressure on the BOE to cut and thus the sterling market.
Below also, following the PMIs we see Aug 4th BOE expectations from BoAML/ JPM - which call for a 25bps cut and 50bn addition to QE (with increased near-term pressure to do so/ act post-PMI) - in which imo will send GBP$ to 1.25, if not through - these expectations are encouraging for shorts thougb it should be remembered the cut was expected in July also but didnt materialise (though the minutes from the meeting did state "most members expect to ease in August". Further we see fresh recession concerns emerge as from Barclays below - once again putting downside pressure on GBP through poor GDP and increased BOE cut likihoods.
Further, on the USD side of the trade, in this risk recovery we continue to view FOMC rate hike expectations rising - aiding dollar topside (and gbp$ downside) - as Fed Funds Futures Opt Implied probs now trade at 19.5% for Sept, 20.8% Nov and 40% for Dec, up from yesterday at 18.8, 20 an 39.8 - the risk-on bias already started today will likely see these probabilities continue to strengthen through the end of the day.
Trading Strategy:
1. So from here after holding shorts at 1.3400 average, given this fresh and extreme impetus for downside - I will continue to hold my cable lower to the 1.285 target (unload 50%) and save 25-50% (depending if i unload 25% at the 1.305 level) for the Aug meeting itself where 1.25 is likely - where before today holding cable seemed more risky as the risks looked skewed to a hawkish BOE, which now has flipped. Unlikely, but any rallies to 1.33-35 level i will be reshorting - cable downside is a function of time imo.
- I like holding short because BOJ are likely to ease, whilst the FOMC stay neutral/ Hawkish, this in turn puts more pressure on the BOE to ease/ GBP - in order to prevent GBP appreciating vs JPY (disinflationairy) BOE must ease too & hawkish FED stance puts pressure on GBPUSD lower.
- Risks to the view continue to be if 1) New/ Weale/ Forbes continue to reiterate their hawkish/ no easing stance and perhaps less impactful; 2) Next weeks UK GDP reading - will not contain much Post brexit data so any upside is unlikely to give GBP strength, though downside is welcomed and could cause further selling (Low pre-Brexit GDP gives BOE more reason to cut)
GBP OIS PRICING A 94% CHANCE OF A 25BPS CUT FROM THE BOE IN AUGUST (85% PRE PMI)
- UK CHANCELLOR HAMMOND: Must restore uncertainty after July PMI
- UK CHANCELLOR HAMMOND: BOE will use monetary policy tools at its disposal
- UK CHANCELLOR HAMMOND: BOE have tools to respond to market turbulence in the short-term
BoAML ON BOE:
- We look for the BoE to cut rates 25bp and increase QE by £50bn in August, split between Gilts and private sector assets.
- BoE inaction so far and heightened policy uncertainty leaves risk-reward unattractive in the front end in our view.
- We prefer to position for potential BoE Gilt purchases, reiterating our 5s20s Gilt flattener as attractive in a QE-scenario.
JP MORGAN ON BOE:
- Current market pricing of a 25bps rate
