Capturing a Pick-Up in Cable VolatilityThe unexpectedly hawkish message delivered by the Fed last week took the markets by surprise, with cable one of the big losers.
Falling from around 1.4120 to touch a low of 1.3787, the pair has since recovered to trade around the 1.3900 handle, still some way off its pre-FOMC levels. The Fed’s message added to the headwinds cable had already been facing following the decision by the UK Government to delay the lifting of final lockdown restrictions by four weeks. However, despite these setbacks, the economic landscape remains supportive for cable to test again this month’s high of 1.4250, with 1.4500 still a target for year-end.
MPC meeting looming
The imminent big data event for cable is Thursday’s meeting of the Monetary Policy Committee (MPC), where the issue is whether the MPC will take its cue from the Fed and signal a more hawkish stance in the face of rising UK inflationary pressures. UK CPI reached 2.1% in May, exceeding the BoE’s 2% target. Clearly this is not in the same ballpark as the 5% rise seen in the US.
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But the MPC has already signalled a willingness to shift to a less-dovish stance, comments suggesting a stronger than expected labour market recovery could see rates raised early H2-2022, alongside a message that inflationary pressures needed to be watched carefully. Similarly, action taken last month to reduce the monthly pace of bond purchases (albeit leaving the overall size of the programme unchanged) does not suggest an economy still requiring excess support.
What will Thursday’s meeting deliver?
The MPC is likely to repeat that current inflationary pressures remain transitory only. But the strong UK data seen over recent weeks will be acknowledged with an emphasis placed on risks being more heavily skewed to the upside. However, any insights regarding the potential timing of when a rate hike might be delivered will remain absent, the expectation being that the MPC will continue to hide behind its requirements of significant progress being made in the elimination of spare capacity and the 2% inflation target placed on a sustainable footing to avoid providing anything more concrete.
What are the risks?
The possibility of a more hawkish message cannot be discounted. Growth, employment and inflation data all continue to print on the topside, while any willingness of consumers to use increased savings to cover current higher prices could quickly see these increases become embedded rather than ‘transitory’. Furthermore, the MPC will not be comfortable seeing CPI overshoot its target level, in contrast to the Fed. Accordingly, there is the possibility that out-going Chief Economist Haldane could be joined in his expected calling for the current QE programme to be halted by one or more of his fellow Committee members.
How to capture any potential increase in volatility
Given the risks associated with Thursday’s meeting, and combined with the positive outlook for cable, volatility in the pair looks relatively cheap. However, the inability of the pair to previously break above the 1.4250 level remains a significant deterrent to expressing any topside view via a naked cash position. Accordingly, using the options market to cover both the risks of the MPC meeting and the potential for anticipated topside gains looks to make sense.
Opinion editorial by Stuart Cole, head macro economist at Equiti Capital
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