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This write-up emphasizes on the cross-asset strategy, the outcome of US-Mainland China trade talks was unclear as were the contours of a Brexit agreement. But at this stage in both sagas, the most-asked question is how much could these two deals still drive markets. If less uncertainty supports global growth as it did following the Asian Crisis, EMU Crisis and EM credit crunch, blue sky targets are at least +10% on Equities, with the usual rotations across regions (into EM), sectors (into Cyclicals) and styles (into Value), plus losses on DM Bonds and the trade-weighted USD and JPY.
But these projections based on history deserve a slight haircut for three particularities of 2019/20:
1) A trade truce without tariff rollback and a Brexit deal without clarity on the UK’s future EU relationship might not drive a significant growth upturn;
2) 2020 US elections create newer uncertainties around tax and regulatory policy; and
3) The central banks won’t reverse their 2019 rate cuts, which limits losses on Bonds. We’ve neutralized Brexit hedges across FX and Rates, but a recent OW of EMU vs US Equities benefits from potential China and Brexit deals.
The base case as outlined by J.P. Morgan economists is less optimistic, specifically that:
a) the odds of a deal by 31st October are very low given the lack of alternative arrangements to the Irish backstop that would be acceptable to the EU and a compressed timeframe, and b) beyond that, the odds of hard Brexit/ no deal around the January deadline have actually increased given recent polls that indicate that the lead of Tories vs. Labour has been relatively stable despite recent events and still suggest on margin a Conservative majority in the elections.
Against these backdrops — not-so-cheap valuations, ongoing political uncertainty with risks of “no deal” still lingering and a more dovish BoE—we view risks to GBP tilted to the downside as well in the near-term and recommend re-selling GBP vs. CHF outright. The immediate catalysts to watch was the Conservative Party conference over the weekend which clearly takes on additional significance as it will shed more light on possible UK proposals.
Towards the end of last week Sterling was able to appreciate spectacularly. Yes of course, everything was pointing towards a Brexit deal - the ideal outcome for GBP-long positions. we looked pretty silly as the old skeptic.
However, today it is no longer sure whether the FX market counted its chickens before they hatched. In any case what the British government has presented is not sufficient for a deal - that much has emerged from Brussels. To formally combine Northern Ireland into the British customs area but to materially leave it in the EU customs area might seem like a good sleight of hand, but it would simply be too obvious that this was just about the Brexiteers savings face on the surface.
We still suspect that there will be any additional substance to imply a breakthrough. Upcoming polls will be important to track as well as they will indicate if the recent dramatic turn of events has affected the support for Tories.
Initiated shorts in GBPCHF outright at 1.22 on September 27th. Stop at 1.2450. Marked at -0.21%.
Stay short a 2M GBPUSD 1.1950/1.15 bear put spread at the beginning of August. Paid 0.66%. Marked at 0.00%.
Probability of a deal raised to 50%, implying further rallies in Cable (GBPUSD) towards 1.30 levels. So, stay defensive at the portfolio level but scale back risk.
While the geopolitics and some optimism on the US-China trade negotiations have lifted the Energy and Base Metals complex.
Contemplating the above perspectives, we come up with some trade updates on crude oil derivatives trades:
Maintain shorts in CME WTI futures for October delivery for arresting downside risks in short-run, simultaneously, longs in CME WTI futures of December’2019 month deliveries.
Stay long ICE Brent Jan’20 on hedging grounds. Courtesy: JPM