Entrenched "Brexit Bias" is why Nomura are "Long EUR/GBP in Summer Markets"

Are you looking to profit on the rising Euro? If so, where and when do you get into the market?

Strategists at investment bank Nomura believe the recent consolidation in the EUR/GBP exchange rate offers just the opportunity to get involved in one of the market’s most reliable trends of 2017.

Strategists - researchers who look for trading opportunities in global financial markets - reckon that while the rally has paused, the Euro’s period of strength is ultimately still not over while a bias amongst media commentators and market participants will continue to weigh on the UK currency.

The call comes at a time when the Pound has traded in a relatively flat fashion against the Euro, not straying out of the region between 1.10 and 1.11 this week.

In EUR/GBP terms this is the range between 0.90 and 0.91.

But Nomura argue that Sterling is set to remain under pressure owing to a pervasive “brexit bias” in which markets discount any good news and choose instead to only focus on the negatives.

It is worth noting that Nomura’s strategy desk has actually been quite constructive on Sterling over recent weeks and months, but they acknowledge this optimism isn’t likely to pay.

“We’ve been more optimistic on GBP than most and the trade worked to begin with until the round of BoE inflation reports that discussed higher rates but ultimately disappointed,” says Jordan Rochester, part of the Global FX Strategy desk at Nomura’s London office.

Rochester acknowledges Sterling faces some considerable headwinds.

An entrenched “Brexit bias” looks to be unshakable amongst market participants; “even the sound of the UK accepting a transition period did little to turn the tide,” notes Rochester.

He makes a fine point:

“Look back at market commentary when UK inflation was rising and you would see the prevailing view was that it was ‘bad for real incomes and so sell GBP’. But when CPI turned lower last month the market train of thought switched to ‘falling inflation means the BoE won’t hike; sell GBP again’.”

This is a currency that just can't catch a break; what readers need to appreciate is that it's rarely profitable to fight such sentiment.

So if the market has adopted this tone with regards to Sterling, what is likely to happen when the next big data releases are due?

Understandably, Rochester isn’t too optimistic heading into the coming week when we have three big data releases - inflation, employment and wages and retail sales.

It will be wages that catch the most attention as rising wages would hint at rising inflation - the kind of inflation that the Bank of England looks at when making policy decisions (as opposed to inflation generated by fuel prices and the falling Pound).

Nomura are wary of a disappointment for Sterling as the headline measure the market follows is a year-on-year rate on a three-month moving average. It is therefore slow to respond to a good run of wage data.

Furthermore, it is also performing a year-on-year percent rate compared with a period of large and rare 1% month-on-month wage rises.

(We’ve seen some good data over the past three months, but this likely won’t be reflected in the headline reading).

So be warned that next week, even if we were to see a strong 0.4% month-on-month rise in headline wages, the headline year-on-year percent measure would fail to rise given its construction.

And with the Brexit bias approach to data being deployed by the media, Rochester says don’t be surprised if the headline that rules the narrative is “Declining real wages”.

“As a result, we’d be comfortable holding short GBP risk over the event,” says Rochester.

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The Pound is a Sell

The Euro is looking good argue Nomura noting that currency flows inspired by the European Central Bank’s quantitative easing programme still need to be unwound.

And, some traders will be looking to avoid betting on the EUR/USD rising incase the US Federal Reserve raises interest rates soon, markets will see, “long EURGBP as the new market way to trade the ECB/EUR view that avoids the event risk of the US CPI number on Friday.”

‘Long EUR/GBP’ simply means buy the Euro against the Pound.

“The disappointing BoE scenario that unfolded last week means our view that UK real rates will eventually improve has been postponed, and short-term selling pressure on GBP is likely to persist with next week’s data unlikely to change the narrative,” says Rochester.

Traders Most Bullish on Euro Since 2011

The foreign exchange trading community might just have turned a little more optimistic on Pound Sterling according to the latest set of data into the workings of the foreign exchange market while bets for further Euro strength grew to their largest volume since 2011.

Weekly figures from the US Commodity Futures Trading Commission shows the speculative market holds bets against the Pound to the value of $2.043 BN.

While sizeable, this is however a decrease in contracts betting on Sterling weakness to the tune of $387 MN when compared to the previous week.

In short, negative positioning on Sterling decreased to the tune of $387 MN which represents a positive shift in sentiment.  

Data from previous weeks suggested negativity was increasing; could the latest data suggest we have seen peak negativity in Sterling?

It is far too early to say what the data means for the Pound's outlook, particularly as the research community are expecting further declines in value of Sterling; for example this week Morgan Stanley researchers said the Pound to Euro exchange rate would fall below 1.0.

But the shift in sentiment is certainly one important clog in the engine of Sterling movement to keep in mind.

Sentiment towards the Euro remains unquestionably positive.

“EUR bulls upped exposure in net terms by 11k contracts (adding another USD1.6bn to the aggregate USD short) to 93.6k, the biggest bull bet on the EUR since 2011,” notes Shaun Osborne, Chief FX Strategist at Bank of Nova Scotia in Toronto.

This is the largest positive bet on the Euro since 2011.

And the Dollar continues to see increased negative sentiment:

“The latest snapshot of speculative FX positioning shows investors continue to add to USD short positioning in aggregate, with a further build in the overall USD short amounting to some USD4.5bn this week; the aggregate bear bet on the USD extends to USD15.6bn this week, the largest since 2013,” says Osborne.