Morning Brief – Thursday 30th

Wide Ranges

Yesterday was a rough day in markets. Equities continued their tumble with key US indices producing price action that could suggest an imminent market correction. Amidst an intensification of the trade war masqueraded as threats of new Chinese economic weaponry, global bond yields continued to tumble. In a bid for safety, the US Dollar continued to appreciate across the board, making notable gains against both the Euro and the flatlining Pound Sterling. US treasuries now trade at their highest price since late 2017. 

Enormous momentum has carried the Pound lower in the past month tumbling from the lofty heights of 1.32 against the US Dollar and 1.18 against the Euro. So, where do we go from here?

Sterling Markets believe it or not are certainly still digesting the tumultuous month of May that saw cross party talks between Labour and the Conservative parties breakdown in yet another Brexit frustration. Add on top of that the recent resignation of our Prime Minister and 11 candidates chomping at the bit for her former post and political risks are significant to say the least. 

Fundamentals in the UK economy look strong and the economic data releases have, by and large, surprised to the upside. However, given the frequency of released observations I am forced to concede that with the original Brexit deadline in March well within the scope of the most recent data, businesses’ scramble to stockpile in case of a disaster no-deal exit ahead of May’s twilight extension agreement could have skewed the results and made them appear overly optimistic. 

Within the GBPEUR and GBPUSD pairs, it’s easy to determine the dominant market expectations. Options markets are a venue to hedge and speculate on price moves between two (or more) assets with a premium representing expectations, differentials and risk. Options markets scrambling to price the value of one Pound versus one Euro or US Dollar make for interesting reading. By and large, the expectation for an appreciation of the Pound against the US Dollar is clear. Bloomberg, a leading financial data provider, collates a survey of economists’ and analysts’ forecasts for the pair. 

The consensus suggests the value of one Pound will rise by approximately one US cent per year each year from 2020. There is also an immense jump through 2020 where December is expected to observe a cable price of 1.40 from these forecasts. The jump is to be anticipated as markets expect Brexit to be resolved and most market participants still anticipate an orderly exit. Watch this space for how this expectation will evolve given the leadership contest that is well under way. With 2021 bringing the EU’s renegotiation of it’s fiscal multi annual financial framework and the UK likely to be well and truly banned from this process and simultaneous membership of the block, the immense revaluation of the Pound prices in expectations for an end to the day to day trivialities of Brexit.

If you look at the implied volatility in options markets and particularly the 10% outlier observations, the wild case pricing of GBPUSD, we can see that a bullish Sterling case sees GBPUSD end up at 1.72 in five years’ time. However, the doomsday scenario has options pricing implying a scenario in which 1 Pound is worth just 94 US Cents. BRACE!

With the political and economic risks engulfing Italy and the rest of the peripheral Eurozone you might expect the call for GBPEUR to be even higher. To those of you reading this and that haven’t fallen into the trap of the previous sentence, well done – GBPEUR forecasts show considerably less consensus displacement than cable.

Economists and analysts see GBPEUR remaining largely range bound partly due to the immensely tight interest rate differential between the negative rate environment of the Eurozone and the muted economic activity of the United Kingdom. Add to this the mutual impact of Brexit on both sides of this pair and the fact that the USD seems later cycle than the Eurozone and you achieve a consensus forecast that GBPEUR will remain within the few cents range that we’ve seen since late 2016.

Doomsday and heyday scenarios stand at 1.40 within GBPEUR and 0.86 in five years’ time. No, 0.86 is not a reading of EURGBP, a commonly quoted convention in forex, we’re talking if it hits the fan then 1 Pound equals 86 cents. Suddenly a holiday in the UK might seem slightly more appealing if this did materialise. 

One thing’s for sure: for a recovery within the Pound and for doomsday scenarios not to be realised, Brexit must be produced in a orderly way that does not upset international order and commerce. 

Discussion and Analysis by Charles Porter

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