Markets Really Don't Think the UK Will BrexitStages of GBPUSD Grief. 2016--Anger, 2017--Depression, 2018--Bargaining, Early 2019--Denial, Late 2019--Acceptance. Price action reflects this.
Ukpolitics
BUY USDJPY @104 & SELL GBPUSD @1.33: RISK-ON, POLITICS, BOJ, BOEThe Federal Reserve's regulatory point man said work to address the lessons of the 2008 financial crisis won't be complete without better regulation of short-term funding both inside and outside the banking system.
St Louis Fed President Jim Bullard may be the Fed's new super dove, but he's no pessimist, he says. Bullard is the lone Fed official forecasting just one additional rate increase, and expects modest growth over the next two and a half years. But he reiterated Tuesday he's not expecting the economy to head south.
Trading Strategy
1. Given this I remain bullish on the $ in the medium term, despite this spike in risk-on which IMO is unlikely to last more than 2wks. In the immediate term I like long $yen as the best play ATM vs other expressions - with a target of 109, entry at 104 as 1) the markets have finally signalled they are ready for a recovery bull run, post the brexit risk-off/ safe haven rally - largley on the back of CB stimulus. I believe USDJPY has been the most sold risk-on asset, thus it is now ripe for buying; 2) JPY fiscal stimulus is likely to come; 3) BOJ is likely to deliver 10-20bps of cuts to its interest rate 4) we have broken the 104 "brexit seller resistance level" which has held since the vote - this break imo means we can now move to 109+ as the recovery leg before resuming lower; 5) the Fed Funds Rate curve continues to steepen across the curve but particularly aggressively in the front end (yesterday 10ys adding 5%) and as a result implied probabilities of hikes continue to rally across the 2016/17 tenors (Dec hike now 33.7% vs 29.2%Mon); 5) check the attached posts for long $jpy support
2. Secondly, short GBP$ is a trade i am closely eyeing.. I am a 70% seller at 1.32 (90% at 1.35) - short GBP rallies is the preferred trade as the BOE is likely to deliver easing in Aug that will drive us down to the 1.25 terminal rate that I have predicted - thus i am hoping we get some "poor information money" flows into GBP up to 1.34/5 going into Friday as 1) UK Political Uncertainty is eased - as Theresa May is the New PM starting Wednesday; 2) GBP buying on Thursday if the BOE doesn't cut rates, whilst I (and the market) believes an august cut is the likelihood instead, given the aggressive GBP selling these past weeks it is prudent to assume quite a large amount of money may/was be betting on a July Cut thus if this "disappoints" some of the market we could see cable trade higher to 1.34+; 3) Long GBP is the risk-on trade, so if risk holds up/ carries on rallying we could see GBP$ take us to 1.34+ - CB and Fiscal stimulus + the fact risk has been depressed for so long, i believe risk has the momentum to rally until the end of the week at least (next risk-rally then looks to 28th July for BOJ stimulus?)
3. The long $Yen and short GBP$ also acts as a dynamic hedge as the long UJ is the risk-on coverage, with the short cable the risk-off half - combining both semi-hedges your exposure, something i like to do when trading.
FED Tarullo Speech Highlights
- "the conditions for destructive runs that threaten financial stability could exist even where no institutions that might be perceived as too-big-to-fail are immediately involved"
FED Bullard Speech Highlights
- Bullard: An unemployment rate around 4.7%, gross domestic product growth of 2% and the Fed' preferred inflation gauge, the personal consumption expenditures index, at 2%.
- "If there are no major shocks to the economy, this situation could be sustained over a forecasting horizon of two and a half years"
- "we have no reason to forecast a recession given the current state of the US economy"
SELL NZDUSD @0.73 - TP 700PIPS: BREXIT, RBNZ, FED & USDJPY HEDGEShort NZDUSD is in my top 2 FX Trades for several reasons:
1. NZD is considered the riskiest G10 currency cross, so NZD trades weaker in risk-off markets, or when equities/ SPX trade lower (you can see the high correlation with SPX at the bottom of the graph).
- With Brexit occurring last week, global risk has increased, this is especially the case for NZD due to commonwealth connections. Therefore NZD is likely to come under pressure in the future as risk-off sentiment continues to dominate, as the US Election nears, Global growth worries continue (Japan, Europe, China) and Brexit/ uncertainty about further EuroArea exits continues to intensify - we can see Gold and US Treasuries continue to gain supporting the risk-off view and thus supporting selling NZD. Also, risk-off encourages $ buying as a safe haven deposit on the Brexit backdrop.
- Further, going into earnings season next week, historically risk currencies (NZD) perform poorly as investors seek safer assets to hedge against earning surprises, thus this helps NZD selling and USD buying. Plus, most investors will want to hold some $ cash in order to fulfil their earnings based equity trading, so this also helps the short Kiwi$ trade by increasing $ demand relative to NZD.
2. The RBNZ Meeting on the 10th August is likely to be dovish and I 80% expect a rate cut of 25-50bps from 2.25% to 2.00%-1.75% , as;1) Brexit risks are weighed in on and potentially priced into a rate decision, in follow up to the supportive/ dovish statements from RBNZ members immediately after the Brexit decision and 2) NZD Macro Environment has performed poorly since the March Rate cut from 2.5% to 2.25% e.g. The last prints still consistently dragging: Retail Sales at 1.0% vs 1.1%qoq & 0.8% vs 1% Q1qoq; CPI 0.4% yoy, 0.2% qoq; Unemployment Rate at 5.7% vs 5.5%. 3) the RBNZ has a historical pattern of cutting their rate every third meeting, and this August meeting is the third meeting. Plus it will have been 5 months since their last cut in March - this also historically is a large time for a another rate cut as previously to that the RBNZ cut in December, Dec-Mar which was only 3 months, and before that in october (oct-dec) which was 2 months so the odds are good if NZD data continues to be bad given the time since the last cut of 5 months is relatively large. And the gap since their last meeting at June 10th is 2 months which is the biggest gap they have.
- Risks to the RBNZ Rate cut view are that;1) Brexit risks are de-priced due to UK Political skulduggery pushing the likelihood of the brexit into 2017 (if at all) 2) Their Inflation, Employment and GDP data manage to recover and show structural signs that the rate at 2.25% is sufficient for continued economic recovery e.g. NZD May Employment Change print surprised to the upside at 1.2% vs 0.8%, and their June GDP outperformed for Q1 at 0.7% vs 0.5% qoq & 2.8% vs 2.6% yoy. So if the CPI and employment data due to be released before the RBNZ August 10th meeting shows a continued/ structural/ aggressive recovery this will reduce the likelihood of a rate cut. Nonetheless, my money is that this isn't the case (with data continuing to trade subdued) and I therefore expect them to provide reassurance to markets with a strong dovish tone, and a 25bps cut - citing Brexit and non-outstanding economic indicators as the impetus for the changed policy.
*It should be noted, in order for me NOT to consider a 25bps cut likely in August we would have to see an outstanding CPI and employment print e.g. CPI 1.0%-0.8% (0.4% last), and unemployment 5.3/4% (5.7% last), given it has been 5 months since the last cut - the RBNZ would be expecting to see such figures to consider the current rate of 2.25% as working/ sufficient.
RANGE BOUND - USDJPY: TRADING STRATEGY - PART 2 Trading for this week:
1. My plan for next week focuses on point "3." from the previous post - I am waiting for risk-on or risk-off assets to confirm investor conviction by using USDJPY as a barometer for net risk sentiment. Despite the market uncertainty and high volatility UJ last week traded within a 200pip range for the between 101.3-103.3. Therefore, I consider a 60pip break of either level to confirm the conviction to a sentiment e.g. 60pips higher is risk-on (Yen selling), 60pips Lower is risk-off (Yen buying).
So of the two possibilities for this week (based on the previous post) Most likely i think is:
1) Global risk continues its recovery as I ask myself what possible risks/ events are there that could tip risk-off sentiment? My answer is none. However, there are several arguments for a risk-on bias e.g. 1) Central bank easing continues to offer risk higher e.g. a dovish RBA (5th) and BOE meeting (14th) price JPY lower and UJ higher
2) Implied vol continues dropping below realised vol, aiding bullish sentiment.
3) Brexit uncertainty continues its de-risking/ pricing as its unlikelihood increases. Further, I think Equities have another week of rallying to price before earnings uncertainty selling will become a factor.
Trading Strategy:
If Yen carries on Ranging I advise buying UJ at lows of the range e.g. between 101.3-101.9 - or you could buy at any price in the range as I have a target of 106 in the near-term and 110+ in the next 4+wks.
Alternatively, I advise placing BUY STOP orders at 103.9-104.2 (level that confirms a risk-on breakout) as there will be 80% of UJ short Stop-Losses at this level, so we will likely see a short squeeze take us 200pips up instantly once UJ trades to at or about 104.
I like owning UJ structurally in the medium term as even if UJ falls lower in the near term which is unlikely (what risk is likely to drive it lower?) as UJ trading at or below 101 (and the further it falls) the more likely the BOJ will be to launch emergency FX intervention and/or near term lower UJ increases odds of an aggressive BOJ cut at its July 28th meeting - which will make UJ trade 500pips+ higher, dependent on the measures/ aggressiveness taken.
For some background/ support for the UJ higher trade
1. based on BOJ easing, recently JPY retail sales disappointed at -1.9% vs -1.6%, as did inflation which was seen at -0.4% nationally for CPI and Core and -0.5% for the same in Tokyo + BOJ's own Core measure continued its strong MoM downtrend at 0.8% (from 0.9% last) - consistently unresponsive inflation is the single biggest driver for BOJ easing/ cutting policy, and the poor inflation has been problematic since the last cut in January 2016 so this gives further weight to another cut, especially since it was 6+ months ago.
- Also BOJ Kuroda and JPY Govt Aso and Abe had several emergency meetings last week as a result of the Brexit vote/ JPY appreciation, in which they discussed FX levels, although taking no action, such rhetoric and actions imply and give likelihood that the BOJ will take substantial action in July.
- Technically, UJ has been oversold for several weeks, even if UJ higher isnt structurally long, we should at least be able to realise a 600-800pip recovery rally before moving lower again.
Volatility
- USDJPY Realised Volatility is trading higher than implied (bullish signal) with 2wk and 1mth at 19.64% & 15.6% vs implied's trading at 11.25% & 13.43% + there are some large notional OTM call strikes at 104.2 and 105, indicating the market may have a bullish bias. Also, the UJ 1wk/1m 25 Delta Risk Reversals Trade at apprx -1.6%, and falling, indicating the market is becoming more bullish by 1) being positioned long in the spot market but buying less downside option coverage and/or 2) Speculative Demand for UJ downside puts is falling.
*Read my previous post "RANGE BOUND - USDJPY: IS THIS GLOBAL RISK RECOVERY REAL? PART 1" for analysis of last week and mo
RANGE BOUND - USDJPY: IS THIS GLOBAL RISK RECOVERY REAL? PART 1Expectations vs Reality:
1. Following the referendum decision on Friday, as expected GBP sold off 10%+, the FTSE plummeted in a similar fashion and global risk assets sold off across the board, but FTSE/ Risk recovered a significant amount of those losses into Fridays close and for the rest of the next week.. So what happened to BREXIT?
- Such behaviour would lead you to believe that the Brexit decision was all just a bad dream, with much of the price action volatility confined to Friday alone - rather where I had expected the decision on Friday to start a cascade of risk-on asset selling, as the brexit backdrop provides the perfect impetus to trigger the risk-off fear for the wider global risks e.g. US Election, Global growth, China Debt - and, ofc, the Brexit Macro economic spill-over itself.
Why did we witness this Risk Recovery Paradox?
1. I think the main reason that risk managed to avoid carrying its bid bias into this week from Friday was PM David Cameron's decision early on Friday/ Monday to 1) Resign in October and 2) Refuse to sign the Article 50 which formally/ actually starts the Brexit Negotiations - the net effect is that brexit risks have been shifted into 2017 (or never) rather than present, thus providing investor confidence to buy risk at its Friday discount (why not) and take bets on a Brexit no show (illustrated by a buoyed GBP which imo should have fallen more).
- What this combination of events now means is that Brexit now trades as a function of Political possibility rather than as a certainty because 1) By resigning in Oct and refusing to start the negotiations now, it means that Brexit itself is put on hold until at least October. Further, the fact that the above is the case, the whole "Brexit" likelihood is brought into question in itself as 1) How likely is the new PM in Oct going to sign the article 50 as soon as they get into office? I think VERY unlikely, its career suicide to start such a volatile process immediately when in office so that means the Brexit Negotiations are pushed further out and likely into 2017 (66.66% chance it occurs in 2017 now from odds-checker). 2) Will Brexit go ahead at all? I think Brexit absolutely is unlikely, as the new PM wont want the economic and political uncertainty that will follow - especially as the vote didnt happen under their leadership - imo its more likely that the new PM will forgo the blame onto Previous PM Cameron and/ or call for a re-referendum or scrap the idea completely and instead offer a solution to solve the "leave" voters problems e.g. Bid to fix EU immigration.
2. Worldwide Central Banks supportive/ Dovish statements - All Major CB have offered their support if their economy calls for it as a result of Brexit - namely the front-end of the FOMC's rate hike curve was severely flattened (Dec or 2017 hike now likely) and the BOE Gov Carney put 250bn in QE and 25bps of Int rate cuts on the cards - the net effect of these actions has been to smooth investor fear, and allow risk to rally, as low rates and QE has no doubt been the biggest driver for stocks in the last 8 years - the FTSE's recovery was/ is 100% underpinned by the BOE stance imo.
3. And the most interesting possibility is that - Investors don't believe in this risk-rally, instead it is just a micro unfolding that will eventually unravel, forcing risk to sell-off in the near future. And by looking at the stability of Gold, Bonds and Yen, this argument does carry alot of weight and is something ive been watching all week. All risk-off assets have traded flat/ higher, despite risk rallying - when risk-on and risk-off assets FAIL to maintain their negative correlation (as they are failing to do now, and are actually slightly positively correlated as they both rise) it usually means the rally is being undermined by a longer-term macro view - since liquidity is a 0 sum game in the long run, all assets cant grow at the same time, either risk must sell-off or
