GBPUSD, EM currencies and the interest rate volatility


The last time GBP/USD hit 1.26 was in June 1985, but we do not see this GBP weakness ending in the short term. We expect our 1.24 target on cable and 0.92target for EUR/GBP to be hit relatively soon, with risks to our GBP views to the downside. Uncertainty about the UK economy’s relationship with Europe is likely to weigh on the currency further, in light of recent signals from the UK government. The consensus view is for JPY to strengthen. We continue to disagree, and see views elsewhere coming round to ours, in line with the price action in USD/JPY, which has had some upside momentum following the break of some technical levels watched by the market. We expect this process has further to run. We express this via long EUR/JPY and target 122.

Yields on core government bond yields have moved higher over the last months, but volatility as implied by the MOVE index has remained very low, as have other indicators like FIX and FX implied vols. Should this remain the case, we do not think EM investors will need to fret. Indeed, EM bond yields have actually dropped over the last 3 months. We expect EM currencies to remain reasonably resilient given that in many places valuations are still reasonable and yield differentials historically wide. Risk premia in EM are not compressed, in contrast to the early 2013 period. This is unlikely to be another ‘taper tantrum’. However, we are watching USD/CNY to see if recent USD strength feeds through, as China’s markets open following holidays.
We stick to our view that EM will remain resilient, if not necessarily completely immune, against external headwinds, and we prefer to buy into weakness where fundamentals are heading in the right direction. We stick to our short USD/BRL, EUR/HUF and long RUB/CAD positions. We think PLN and IDR will also outperform. The weakness of CAD is notable in light of oil price strength, and we stay short CAD/NOK.