FxWirePro: What’s Engulfing Sterling’s Long-Term Prospects? Take A Glance At Short GBP Trades

In the UK, PM Borris Johnson cautioned a ‘second wave’ of Covid-19 cases has started in Europe and it was revealed that travellers to Belgium, Luxembourg and Croatia face quarantine measures on return to the UK. The International Air Transport Association was reported as not seeing global air travel returning to pre-Covid-19 levels until at least 2024.

While the negotiations at this week’s EU council summit and the subsequent recovery fund agreement offered a reprieve from the infection- and mobility-laden market obsessions of late. In the event, the conclusion of the recovery fund deal propelled EUR to not only year-to-date highs but to levels not seen since late 2018. It, therefore, seems that the compromise to a lower level of grants, at least in the near-term sense, was more impactful in its symbolism more so than the specific terms themselves, and indeed peripheral spreads continue to narrow (refer above chart). The path higher from here for EUR on a broad basis may be somewhat more resistant given a combination of current positioning, fair value indicators and August liquidity, but longs vs GBP still benefit from idiosyncratic downside out of the UK and discounts to the USD given its own near-term issues also could prove supportive. GBP was firm this week, outpaced only slightly by EUR on net as the focus turned from the recovery fund tailwind quickly back to Brexit negotiations. As is clear now, PM Johnson’s initial hope of striking a deal-in principle by July is unmanageable. News reports this week indicated that no deal has effectively become the government’s base case and that WTO trade terms are the expectation for the future trade relationship. This was a downbeat take on negotiations and leaves the two sides just next week to make material progress before a break in talks until August 17. The break will necessarily narrow the window yet further to find an agreement, and would seemingly force investors to increasingly contemplate (and price) the likelihood of a disruptive outcome in 2021. The lack of Brexit developments in early August could also reorient the market’s attention on GBP’s lagging economic response and structural deficiencies which remain active structural risks on top of Brexit. Contemplating above factors, below trade tips are suggested.

Long EURGBP from 0.895. Currently, trading at 0.9061, marked at +1.50%, SL 0.8940.

Short GBPCHF at current levels of 1.1874 with strict stop loss 1.1937.

Alternatively, on hedging grounds we advocated shorting GBPUSD futures contracts of mid-month tenors, we wish to uphold the same strategy as the underlying spot FX likely to target southwards below 1.23 levels in the medium run (spot reference: 1.2929 levels). Writers in a futures contract are expected to maintain margins in order to open and maintain a short futures position. Courtesy: JPM