FxWirePro: UK & EZ PMIs Upbeat Consensus But Contraction Unlikely To Cheer, Wise Hedging Needed For EUR/GBP On Brexit Negotiation

Sterling has seen a nice rise over the past days. However, we still urge cautious approach, since the move is rather related to overall positive market sentiment than to intrinsic GBP strength. Even more so as according to Bank of England Governor Andrew Bailey the BoE does not rule out negative rates ("we do not rule things out as a matter of principle"). Moreover, inflation has slipped to levels not seen since 2016 and is likely to fall further and drop below zero in summer. Honestly, nothing to really get exited about in Sterling.

In particular as the friendship between the two chief negotiators in the Brexit case, Michel Barnier and David Frost, seems to be ending. Frost describes Barnier's proposals as "unworthy", Barnier replies “I would not like the tone that you have taken”, demands that rules for access to the common market be respected and raises again the words "cherry picking" in respect to Frost trying to get the best deal with a minimum of commitment. Only one further round of negotiations is planned, starting June 1, before the next EU summit in June will take place. It is unlikely that the differences will have been resolved by then. A withdrawal of Great Britain without a deal at the end of the year seems increasingly likely. 

On data front, the UK PMIs registered noticeable improvements in May, rebounding from the drops to record lows set in April. The ‘flash’ manufacturing PMI rose to 40.6 from 32.6 previously, while the services reading picked up to 27.8 from 13.4 in April, driving a pick up in the composite PMI to 28.9 (previously, 13.8). It should be noted, however, that these advances come after a month of record deteriorations in April as the UK went into full lockdown mode.

While the IHS Markit Eurozone Manufacturing PMI rose to 39.5 in May 2020 from 33.4 in the previous month and beating market expectations of 38, a preliminary estimate showed. The reading pointed to the second sharpest contraction in the factory sector on record, amid non-essential business closures due to the coronavirus pandemic. Services PMIs in the region increased to 28.7 in May 2020 from 12 in the previous month and above market forecasts of 25, a preliminary estimate showed.

Although these economic leading indicators show some ray of hope, we are still dubious as the readings pointed to the steepest contraction in both manufacturing & services sectors since comparable series began in June 1997, as social distancing and other coronavirus-related lockdown restrictions continued to hit majority of the businesses.

Firms are already struggling enough with the current crisis and now will seriously have to consider this option with all the possible consequences and get prepared. All this argues for rising volatility (i.e. more expensive hedging) and downside risks in the Pound are on the cards against euro and other major pairs.

Hence, long hedges are advocated via EURGBP CME futures of June deliveries with an objective of arresting foreseeable upside risks.

Alternatively, on trading perspective, at spot reference: 0.8996 levels, it is advisable to trade one-touch call option strategy using upper strikes at 0.9050 levels, the strategy is likely to fetch leveraged yields as the underlying spot FX keeps spiking further towards upper strikes on the expiration.

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