Global Markets and GBP

Our measure of implied G10 and EM FX volatility (FXVIX Index) has started to rise in recent weeks, while US equity market volatility (VIX Index) is continuing to float around lows. Since we are not even close to the volatily seen around the June UK referendum, FX trends are difficult to come by.
GBPUSD implied volatility has come down to levels last seen in March, a time when we saw a similar-sized divergence in the UK and US economic surprises. The strength of post Brexit data, much BoE easing already priced into the rates market and a generally weak USD should allow GBPUSD to rally towards 1.3450. Large long positioning in EURGBP also makes the pair prone to a correction down to 0.8300, around the July 14 low. It appears that the cheaper currency is already doing its job at attracting foreigners into GBP assets. Retail sales rose by 1.5% in July, driven largely by higher tourist figures who were buying the non-food items. Luxury goods retailers, like those selling Swiss watches, are already seeing a pick-up in spending, particularly as prices haven’t been put up across the board. We will be watching the UK CBI sales data release for August tomorrow to see if the trend continues. Foreign corporates are on a UK spending spree too. Announcements of M&A into the UK have reached £40.7 billion in 3Q already, only a fraction lower than the average for the past few years. The latter is only currency-supportive if the purchase is made using cash in a foreign currency. The BoE’s corporate bond purchase programme is incentivising corporates to issue GBP debt, which, if used to make an acquisition, would reduce the currency-supportive impact.

Yesterday’s relatively strong eurozone PMI coming in at 53.3 showed that it is not only the EUR currency flow dynamics and a weak USD driving EURUSD higher. At the same time as eurozone data are staying steady, US core data (retail sales, durable goods, CPI) continue to weaken. The difference in economic surprise indices between the eurozone and US has picked up significantly since July, reaching similar levels to when EURUSD was trading at 1.15 back in May. We target 1.16 for the end of this quarter. An extension of the QE programme or even another rate cut by the ECB isn’t going to stop EUR from its appreciation path, we think. The inability for the ECB to push down long-term bond yields in the eurozone makes it difficult for monetary easing to translate into currency weakness. An alternative to trading a higher EUR is trading higher SEK on the crosses. For now we think that EURSEK should stay relatively range-bound, between 9.30 and 9.50, allowing us to trade crosses like short AUDSEK. In Australia the data are pointing towards weakness in 2Q. Construction data out overnight showed that the mining sector is still in a period of adjustment, with resources sector construction falling by 14.3% in 2Q, now down 36.5% since last year. Even though the housing market is showing signs of an upturn recently, with the proportion of houses sold that are taken to auction reaching 86% in Sydney, 12 percentage points higher than a year ago, it is not inspiring investment. Should this optimism not carry through into more residential construction activity, where 2Q only saw a rise of 0.8%Q, then there is a risk that the RBA is going to have to ease further to support the broader economy. We prefer not to trade oil currencies outright at the moment due to the wild swings created by headlines from OPEC members suggesting that they could look for a production freeze. The API inventory data showed a sizable build of 4.46 million barrels in the past week, relative to market expectations for a slight reduction. Instead we choose to play short CADNOK, which takes out some of the oil risk. Today’s Norway investment data should show another contraction, but this is already assumed by the market.