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GBP had not rallied even though the subjective probability of a disruptive no-deal Brexit had receded materially over the prior month. This anomaly was corrected with a vengeance in January as GBP rallied by a chunky of 4.5%. But having first undershot in response to favourable developments around the risk of no-deal, it appeared to us that GBP was in danger of over-reacting and was moving from merely removing the negative tail-risk of no-deal, which we estimate to be worth about 3% to GBP’s probability-weighted value, to beginning to price a materially higher probability of no-Brexit. This was premature, in our view, and the subsequent 1.5% correction lower in GBP tends to support such an assessment.
The one pushback against selling GBP vs. JPY correlation at the current market is value, or rather the lack thereof. Implied corrs have already subsided 15% pts. from their local December peak to near 2-yr lows and carry only thin premium over trailing realized corrs. Within the GBP-cross universe, somewhat better value resides in GBPAUD options where nominal implied corrs. are 15-20 pts. higher, and which also incidentally ranks second next only to GBPJPY on long-horizon risk-return metrics from corr. selling in Exhibit 5 (highlighted in blue).
Unlike GBPJPY however, GBPAUD is not a symmetrically profitable triangle play in calls and puts: Exhibit 5 suggests that owning GBP calls/AUD puts (against selling GBPUSD calls and AUDUSD puts) significantly outperforms owning GBP puts/AUD calls, presumably on account of GBPAUD’s traditional anti-risk sensitivity on the upside (i.e. spot tends to rally sharply in crashes).
Fortunately, this directional preference suits current tactically bullish GBP views to a tee, hence GBP call/AUD put spreads financed with AUD put/USD call spreads is a viable alternative to our GBPJPY – USDJPY call spread switch for expressing a constructive view on Brexit negotiation outcomes. Sterling appears to be turbulent in the weeks to come, we run you through hedging scenarios of Brexit risks in our upcoming post. Courtesy: JPM
Currency Strength Index: FxWirePro's hourly GBP spot index is flashing at -92 levels (which is bearish), hourly USD is at -4 (neutral), hourly JPY spot index was at 103 (bullish) and hourly AUD is 136 (bullish) while articulating at (12:07 GMT).
For more details on the index, please refer below weblink: http://www.fxwirepro.com/currencyindex
