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This write up emphasizes on the prevailing shorts in GBP and those who squared off let’s reopen a bearish basket (stay short cable in cash, buy a 2-m EURGBP call spread), we bought cable two weeks ago as this was the most misaligned USD pair on an interest rate basis, and so offered reasonable leverage to the prospect of a hawkish Fed.
The FOMC may have disappointed but this has done comparatively little to close the valuation gap–fair-value for cable based on 2Y rate differential now stands at 1.17 compared to 1.15 when we entered the trade. As such, we’re in no real rush to close the cable position, albeit we are reducing the beta to the dollar by opening a long position in EURGBP.
We are not convinced that the UK economy will justify a broader shift of opinion on the MPC, albeit we do acknowledge that the dissent from arch-hawk Forbes this week together with subtle changes to the language in the minutes does indicate that the economic bar for the Bank to act is lower than we had thought (this bar is not lower than the 1.0-1.5% GDP run rate we expect the economy to deliver in 1H).
On a relative basis, meanwhile, it’s worth noting that there’s almost as much tightening priced for the ECB by the end of 2018 as there is for the BoE (EONIA prices 22bp while a full hike is now priced by the Sonia curve in Nov18, only a month earlier than before this week’s MPC).
We hence continue to regard EURGBP as a viable EUR recovery trade, both on economic and also political ground. That being said, we prefer to express this through options given UK data risk next week (CPI, retail sales). Also, 2m implied vols that span the second round of the French vote are within 0.8 points of the 1Y low and also within a point of 2-mo realized vols, so comparatively cheap.
Buy a 2-mo 0.8820-0.9050 EURGBP call spread for 62bp. Spot reference 0.8681.
Short GBPUSD from 1.2250 March 3. Marked at -1.04%.
