Global FX GBP. GBP: Maintain bearish view amid uncertainties related to Brexit talks. March 30, 2017

Transcription

1 Global FX GBP Treasury Research Group For private circulation only GBP: Maintain bearish view amid uncertainties related to Brexit talks We continue to maintain bearish outlook on Sterling Expect Sterling to trade to 1.18 against US Dollar by year-end Uncertainties related to separation talks, and expectation of BoE remaining on hold for 2017 are main reasons for the view Historically high speculative short positioning may deter any sharp Sterling fall or may cause short-squeeze in the near term UK 10Yr bonds reflecting the pessimistic view on economy, despite rise in leading indicators Maintain bearish view on Sterling, targeting 1.18 against US Dollar by yearend Article 50 has now been triggered and the two year window for negotiation of a withdrawal agreement has started. The two-year negotiation period will require the governments of both sides to talk about trade deals, immigration, passporting rights, security etc. and poses significant source of uncertainty as UK Prime Minister Theresa May has indicated a possible Hard Brexit. Amid all this uncertainty and threat of slowdown in growth momentum, we expect the Bank of England (BoE) to remain on hold for entire 2017 despite rising inflationary pressure. Consequently, we maintain our bearish view on Sterling, targeting 1.18 against US Dollar by year-end. UK government bonds are already accounting for pessimistic outlook on domestic economy, with recent sell-off in 10Yr bonds not being in line with other major global peers. Possible weakening of the economic growth, amid rising inflation March 30, 2017 Please see important disclaimer at the end of this report Pradeep Goyal goyal.pradeep@icicibank.com Latest released economic data from UK suggest that the UK economic momentum may be falling after witnessing above expectations growth post Brexit. While manufacturing and industrial production have started coming down, the rising manufacturing PMI is still way behind the broad based rise in global manufacturing PMI, suggesting that UK is still way behind the global growth momentum. We think it s still too early (based on latest data prints) to decide if Brexit is having any negative impact on the UK economy, and would like to wait for more data prints to draw a conclusion. On inflation side, the headline CPI is on a rising trend, with latest CPI coming at 2.3%YoY, significantly above BoE s threshold of 2%. However, the recent gains are on account of sharp fall in Sterling post Brexit. We expect inflation to normalize towards end-2017 or early-2018 as the effects of fall in Sterling post Brexit, along with energy prices base effect, starts eroding. However, other supportive measures for inflation tell a different side. Rise in wage growth has not been able to keep pace with continuously falling unemployment rate, with latest earnings estimate being significantly low. Similarly PPI has also been falling, suggesting that underlying factors are still not in place to take inflation higher on a sustained basis.

2 May'17 Jun'17 Aug'17 Sep'17 Nov'17 Dec'17 Feb'18 Mar'18 Global FX - GBP UK Economic data heatmap Feb-17 Jan-17 Dec-16 Nov-16 Oct-16 Sep-16 Aug-16 Jul-16 Jun-16 May-16 Apr-16 Mar-16 Feb-16 Industrial production (%MoM) Manufacturing Production (%MoM) Manf PMI Retail Sales (%MoM) Unemployment rate CPI (%YoY) Avg weekly earnings (%YoY) PPI (%MoM) In the table above green scale indicates better economic performance and the red scale implies worsening performance Article 50 got triggered; separation talks between UK-EU source of uncertainty Article 50 has now been formally triggered and the two year window for negotiation of a withdrawal agreement has started. Without an agreement on exit or agreement on a transition period, the UK would exit automatically the EU on 30th March We expect separation talks not to be straight forward, with PM Ms Theresa May, in her January speech, saying that no deal is better than a bad deal, suggesting the higher likelihood of hard Brexit. It s highly unlikely that EU will be willing to negotiate freetrade agreements with UK while the latter is looking for immigration bans from European countries. Further, UK s threat of significant reduction in EU tax collections may probably cause EU to adopt a tough stance. Given the rise of populist or anti-euro parties in various countries in Europe, we think that EU officials will be afraid of giving any freebies to UK as it might encourage other member states to break away. The possibility of second Scottish referendum adds more fuel to Brexit worries. Date Event 29-Mar-17 After invoking the Article 50, European Commission to issue "draft negotiation guidelines" 29-Apr-17 EU27 summit to agree on negotiation guidelines and way forward 7-May-17 Result of French Presidential elections EU Summit; potential meeting when EU and UK may 22/23 Jun 2017 agree of negotiation timeline 24-Sep-17 German elections 1-Feb-18 1-Oct Mar-19 Brexit negotiations timeline Italy elections 1) Target date set by EU for conducting negotiations, in order to allow time for them to be ratified before the end of two-year Article 50 deadline. 2) Possible Scottish second referendum on Scottish independence after the terms of the deal are known and before end-of Brexit. 2 year period for Article 50 expires. In summary, the two-year negotiation period will require the governments of both sides to talk about trade deals, immigration, passporting rights, security etc. and poses significant source of uncertainty. BoE expected to be in wait-and-watch mode While BoE turned slightly hawkish in its March meeting on the back of rising inflation, we expect the central bank to remain on a wait-andwatch mode for The main reason behind central bank s expected status-quo approach is the fact that there are too many uncertainties as EU-UK separation talks begin, which will potentially exert a significant drag on economic growth. Rising inflation should not cause too much worry to the BoE as underlying factors are still not in place to take is sustainably higher. However, we would like to note that the UK economy has been performing above expectations post Brexit which has surprised everybody. And if uncertainties related to separation talks don t really cause much drag on growth, BoE will be under pressure to reduce accommodation amid rising inflationary pressures. 20bps of rate hike pricing by Mar 18 looks aggressive (bps) BoE rate hike pricing Currently, markets are pricing close to ~20bps of rate hike by BoE in next one year, which looks a bit aggressive in our view. 2

3 Mar-07 Mar-08 Mar-09 Mar-10 Mar-11 Mar-12 Mar-13 Mar-14 Mar-15 Mar-16 Mar-17 Jan-15 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Jan-16 Mar-16 May-16 Jul-16 Sep-16 Nov-16 Jan-17 Mar-17 Jan-15 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Jan-16 Mar-16 May-16 Jul-16 Sep-16 Nov-16 Jan-17 Mar-17 Global FX - GBP Maintain a bearish view on Sterling Given our expectation of Hard Brexit, BoE remaining on sidelines for 2017 and too many moving parts related to EU-UK talks and potential fallout on economic growth, we maintain a bearish bias on Sterling, targeting it to fall to 1.18 against US Dollar by year-end. Given so many uncertainties, any sort of monetary policy inconsistencies by BoE would be highly disruptive. As such, it would be wise for the BoE to remain on sidelines, and do less rather than more. With Fed tightening and ECB becoming less dovish, we think that Sterling is biased to trade on the downside against both USD and EUR. Yield differential suggest Sterling is slightly overvalued Our Sterling s fair value model, which uses US-UK 2yr nominal yield spread, suggests that currently Sterling is slightly overvalued, with its fair value around ~1.20 against US Dollar. Its deviation from fair value is close to the upper end of the historical range, suggesting that the currency should fall. Going ahead, our expectation of US front-end yields to rise further due to Fed rate hike expectation and UK yields to remain range-bound due to BoE s status quo will lead to a rising yield spread, which is expected to cause further downside in the Sterling. Our model implied GBPUSD fair value implies Sterling being slightly overvalued Actual vs model value difference close to high-end of recent historical range Actual Model implied (%) Residual Sterling overvalued Sterling undervalued Historically highest Sterling short positioning obstacle to further Sterling weakness The historically highest CFTC speculative short positioning, surpassing the post Brexit high, acts as a hindrance to any sharp fall in Sterling in the near term. While large short positioning makes Sterling vulnerable for a shortsqueeze, we remain sellers of Sterling on any uptick. UK government bonds price in pessimism as Article 50 gets triggered While 10Yr UK government bond (Gilt) yields have recovered from post Brexit lows, they still appear to be pricing in pessimistic outlook on the domestic economy, despite rising leading economic indicators. The Gilts have outperformed on cross-country basis, with Gilts sell-off remaining limited compared to US and German 10Yr bonds. Historically highest short speculative positioning ('000 contracts) Going ahead, we expect Gilt yields to remain suppressed, with a chance of further falls in yields on any negative news flow coming out of negotiations. On cross-country basis, we continue to expect UK government bonds to outperform on the basis of 1) BoE remaining on hold 2) expectation of medium term weakness in UK s economic growth GBP CFTC positioning GBPUSD (RHS)

4 May-14 Aug-14 Nov-14 Feb-15 May-15 Aug-15 Nov-15 Feb-16 May-16 Aug-16 Nov-16 Feb May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar-17 Global FX - GBP Gilts posing pessimistic picture compared to other lead indicators Limited sell-off in Gilts results in widening crossmarket spread Composite PMI 10Yr bond yield (RHS) (%) (bps UK US Germany 4

5 Global FX - GBP ICICI Bank: ICICI Bank Towers, Bandra Kurla Complex, Mumbai Phone: (+91-22) Treasury Research Group Economics Research Sunandan Chaudhuri Senior Economist (+91-22) sunandan.chaudhuri@icicibank.com Kamalika Das Economist (+91-22) (ext. 6280) kamalika.das@icicibank.com Samir Tripathi Economist (+91-22) samir.tripathi@icicibank.com Niharika Tripathi Economist (+91-22) (ext. 6943) niharika.tripathi@icicibank.com Pradeep Goyal Economist (+91-22) (ext. 6229) goyal.pradeep@icicibank.com Sumedha Dasgupta Economist (+91-22) (ext. 7243) sumedha.dasgupta@icicibank.com Renuka Khadke Economist (+91-22) (ext. 8976) renuka.khadke@icicibank.com Sri Kadiyala Economist (+91-22) (ext. 7206) sri.kadiyala@icicibank.com Treasury Desks Treasury Sales (+91-22) Currency Desk (+91-22) Gsec Desk (+91-22) FX Derivatives (+91-22) /43 Interest Rate Derivatives (+91-22) Commodities Desk (+91-22) Corporate Bonds (+91-22)

6 Global FX - GBP Disclaimer Any information in this should not be construed as an offer, invitation, solicitation, solution or advice of any kind to buy or sell any financial products or services offered by ICICI Bank, unless specifically stated so. ICICI Bank is not acting as your financial adviser or in a fiduciary capacity in respect of this proposed transaction with you unless otherwise expressly agreed by us in writing. Before entering into any transaction you should take steps to ensure that you understand the transaction and have made an independent assessment of the appropriateness of the transaction in the light of your own objectives and circumstances, including the possible risks and benefits of entering into such transaction. You may consider asking advice from your advisers in making this assessment. No part of this report may be copied or redistributed by any recipient for any purpose without ICICI s prior written consent. Disclaimer for US/UK/Belgium residents This document is issued solely by ICICI Bank Limited ( ICICI ). The material in this document is derived from sources ICICI believes to be reliable but which have not been independently verified. In preparing this document, ICICI has relied upon and assumed, the accuracy and completeness of all information available from public sources ICICI makes no guarantee of the accuracy and completeness of factual or analytical data and is not responsible for errors of transmission or reception. The opinions contained in such material constitute the judgment of ICICI in relation to the matters which are the subject of such material as at the date of its publication, all of which are expressed without any responsibility on ICICI s part and are subject to change without notice. ICICI has no duty to update this document, the opinions, factual or analytical data contained herein. The information and opinions in such material are given by ICICI as part of its internal research activity and not as manager of or adviser in relation to any assets or investments and no consideration has been given to the particular needs of any recipient. Except for the historical information contained herein, statements in this document, which contain words or phrases such as 'will', 'would', etc., and similar expressions or variations of such expressions may constitute 'forward-looking statements'. These forward-looking statements involve a number of risks, uncertainties and other factors that could cause actual results to differ materially from those suggested by the forward-looking statements. ICICI Bank undertakes no obligation to update forward-looking statements to reflect events or circumstances after the date thereof. Nothing contained in this publication shall constitute or be deemed to constitute an offer to sell/purchase or as an invitation or solicitation to do so for any securities or financial products of any entity. ICICI Bank and/or its Affiliates, ("ICICI Group") make no representation as to the accuracy, completeness or reliability of any information contained herein or otherwise provided and hereby disclaim any liability with regard to the same. ICICI Group or its officers, employees, personnel, directors may be associated in a commercial or personal capacity or may have a commercial interest including as proprietary traders in or with the securities and/or companies or issues or matters as contained in this publication and such commercial capacity or interest whether or not differing with or conflicting with this publication, shall not make or render ICICI Group liable in any manner whatsoever & ICICI Group or any of its officers, employees, personnel, directors shall not be liable for any loss, damage, liability whatsoever for any direct or indirect loss arising from the use or access of any information that may be displayed in this publication from time to time. This document is intended for distribution solely to customers of ICICI. No part of this report may be copied or redistributed by any recipient for any purpose without ICICI s prior written consent. If the reader of this message is not the intended recipient and has received this transmission in error, please immediately notify ICICI, Samir Tripathi, samir.tripathi@icicibank.com or by telephone at and please delete this message from your system. DISCLAIMER FOR DUBAI INTERNATIONAL FINANCIAL CENTRE ( DIFC ) CLIENTS: This marketing material is distributed by ICICI Bank Ltd., Dubai International Financial Centre (DIFC) Branch and is intended only for professional clients not retail clients. The financial products or financial services to which the marketing material relates to will only be made available to a professional client as defined in the DFSA rule book via section COB Professional clients as defined by DFSA need to have net assets of USD 500,000/- and have sufficient experience and understanding of relevant financial markets, products or transactions and any associated risks. The DIFC branch of ICICI Bank Ltd., is a duly licensed Category 1 Authorized Firm and regulated by the DFSA. DISCLOSURE FOR RESIDENTS IN THE UNITED ARAB EMIRATES ( UAE ): This document is for personal use only and shall in no way be construed as a general offer for the sale of Products to the public in the UAE, or as an attempt to conduct business, as a financial institution or otherwise, in the UAE. Investors should note that any products mentioned in this document, any offering material related thereto and any interests therein have not been approved or licensed by the UAE Central Bank or by any other relevant licensing authority in the UAE, and they do not constitute a public offer of products in the UAE in accordance with the Commercial Companies Law, Federal Law No. 8 of 1984 (as amended) or otherwise. 6