GBP: Reasons to worry? - BAML

Politics, more than data, matter for GBP and with a heavy Brexit calendar through to year-end according to Kamal Sharma, FX Strategist at BofA Merrill Lynch and suggests that they take this opportunity to establish a GBP short.

Key Quotes

“We think markets are unprepared and vol looks cheap given that major GBP moves this year have been driven by Brexit news rather than data. IMM positioning is close to neutral in GBP. We doubt investors have any appetite to take on long positioning ahead of key events. Potential for heightened Euro-sceptic noise around the Conservative Party conference is a particular risk. Using spot reference 1.2980 we buy a 6m GBP/USD put with strike at 1.25 which costs 122.80 USD pips. We think the political and seasonal headwinds are likely to intensify.” 

“UK Data and GBP is so 2016

The correlation between GBP and UK data surprises remains weak. We continue to believe that the bulk of currency adjustment took place in the immediate aftermath of the of EU Referendum vote as analysts aggressively marked down their growth forecasts. Any downside risks to GBP from slowing growth are limited as the UK rates market is showing no haste to price in renewed policy accommodation. Indeed we continue to believe that the risks to GBP from a move in rate expectations are to the upside if the Bank of England delivers a rate hike.” 

“Trading the transition “put”

We expect that a transitional agreement will eventually be reached given the broad consensus on both sides on the need for one. But whilst this appears to have placated markets concerns of a ‘cliff-edge’ our surveys suggest that investors expect that such an agreement could be reached, potentially sooner rather than later. Markets will therefore be increasingly focussed on this announcement in the coming months but our concern is that investors may be disappointed given the lack of progress so far in the Brexit negotiations. This suggests fading GBP support from the transition put.” 

“Party conference could indicate level of euro-sceptic concern

The UK Government is expected to publish a series of positional papers in the coming months setting out its Brexit strategy in various areas of the negotiations. The July positional paper on ECJ oversight highlighted the divisions within the UK cabinet. Indeed, the depth of Euro-sceptics’ concern may become more apparent at the Conservative Party Conference in late September. PM May’s speech last year to that audience was the catalyst for sharp GBP declines culminating in the October ‘flash crash’.” 

“Risks 

With little progress made in the negotiations so far, there are risks on both sides of our central scenario of a hard Brexit with extended transition. Our worst case scenario for GBP remains talks breaking down completely whilst domestic politics also present downside risks to sterling. On the flip side, a speedy agreement on the ‘divorce’ bill and EU citizens rights would facilitate new trade deal talks, which if successful, would be bullish for GBP and potentially pave the way for UK rate hikes.”