GBP/USD: Sell on Rebounds Say Morgan Stanley and Soc Gen Strategists
The British pound has recovered to highs of 1.4362 against the US dollar and both Société Génerale and Morgan Stanley say this strength should prove temporary.
The British pound has eked out gains against the US dollar over the latter part of the week gone by - the spot rate has recovered back towards the late 1.42's ensuring retail interenational payments have now moved back up to 1.40 with some providers.
Be warned the gains could be short-lived though as markets will be viewing the recovery as a period of short-covering -i.e. a bounce that had to occur simply because of how oversold the recent sell-off has been.
Strategists are sniffing opportunity.
SocGen’s Olivier Korber suggests trading put options to take advantage of the GBP/USD down-trend:
“Cable is falling vertiginously."
He says in a recent note:
“It could fall further, but more slowly given its fast pace lately.
“The bearish inertia will be maintained by BoE dovishness, room for lower UK rates, falling wage inflation, twin deficits, and the rising Brexit risk.”
Korber argues there is now a lower risk of a sudden short-covering rally given the short-trade has become less crowded:
“With short positioning not that extreme, short covering risks are limited. A rebound is unlikely at this stage.”
He suggests using European Digital put options with a strike price just below 1.4000.
Latest Pound / US Dollar Exchange Rates
  | Live: 1.3337▲ + 0.08%12 Month Best:1.3789 |
*Your Bank's Retail Rate
| 1.2884 - 1.2937 |
**Independent Specialist | 1.315 - 1.3204 Find out why this is a better rate |
* Bank rates according to latest IMTI data.
** RationalFX dealing desk quotation.
These options have the unique characteristic of paying out in full on maturity if the exchange rate has fallen below the strike price regardless of by how far, therefore allowing for a minimal move south in the pair.
“Further decline would put cable in a 1.35-1.40 range, with significant uncertainty about where it would trade in this area in a few weeks.
“Therefore, the payoff should generate its maximum leverage not too locally, and close to the current spot.
“It suggests Buying a 2M (2-month) European digital put with a strike just below 1.40.”
The SocGen analyst also recommends placing a knock-out – which is a condition which if breached would cancel the option - below the key 1.3500 low of the early 80’s which Korber thinks is highly unlikely to be breached.
Introducing a Knockout would have the advantage of increasing the potential payoff of the option.
Morgan Stanley Adopt Perma Bear Stance
Morgan Stanley meanwhile see short GBPUSD as their most favoured G10 FX trade.
Analysts at the investment bank are even more bearish than SocGen’s Korber, seeing the pair potentially falling all the way down to 1.3000, due to its high correlation with volatility and risk-off:
“We have become increasingly bearish on GBPUSD over recent months because the currency is one of the most vulnerable within the G10 to external shocks, market volatility and a global trade decline.”
Morever they do not see the risk of a Brexit as fully priced in and expect sterling to decline further once the date has been set for a referendum, which they suggest is likely after the European Commission meet on the 18-19 of February, when they will discuss David Cameron’s proposals for revising the current arrangement between the U.K and the E.U.
“Market concerns over a Brexit will only come into play once a date for the referendum is set.”
The report also highlights the UK’s dependence on Financial Services and Oil as creating downside risks for the currency:
“The UK’s GDP is highly dependent on the financial services sector, which is prone to weakness when exposed to higher volatility.
"UK equity indices are also energy (24%) and financials (23%) heavy, suggesting that foreign investors may be more likely to pull their money out, leading to currency depreciation.”
The inflows from investors buying gilts in anticipation of a rate hike during 2015 have slowed and are expected to slow even further as 2016 progresses:
“2015 saw foreigners flock back to gilts, with the 12m purchases to November reaching £68.2 billion, a figure that has only been surpassed during the eurozone crisis in 2010.
“As the market expects the BoE to stay on hold for longer and Brexit risks to rise throughout the year, then inflows into UK markets may start to slow, no longer providing the GBP support they have in the past.”
The fall in the price of oil has particularly hit foreign direct investment in oil and gas, which has impacted on the current account, and Morgan Stanley expect the fall to lead to weaknesses for GBP against EUR and SEK especially, since both these have positive current account balances.
From a technical perspective they see the 1.4000 level as a key support level, with a break below that opening the way up to a move down to 1.3800.
