FxWirePro: Bullish/Bearish Scenarios of Sterling Ahead of BoE & Fed's Monetary Policies - GBP/USD OTC Indications and Hedging Perspective

All eyes are curiously focused on the two-day FOMC monetary policy meeting which concludes later today with investors assigning 70% probability for a further 25bps hike in the target rate to a range of 2.25% - 2.50%. However, rising signs of slowing growth in a number of the world’s big economies and US equity markets’ recent hefty losses support the view that the Fed is likely to take a pause in its rate tightening cycle earlier than previously thought.

On the flip side, Bank of England (BoE) is also scheduled, that is not expected to adjust monetary policy at the meeting on Thursday. The macro picture has worsened somewhat recently, while Brexit uncertainty has increased. BoE likely to maintain its current guidance i.e. limited and gradual hikes going forward.

Bearish GBPUSD scenarios, if: 

1) Fed surprisingly hints for extension of hiking cycle

2) A no-deal Brexit (GBP -10%). 

3) PM May resigns and/or is replaced by a harder-Brexiteer following the defeat of a Brexit motion in parliament.

Bullish GBPUSD scenarios, if: 

1) BoE abruptly adds stimulus, prepones a hiking decision, though the market does not expect the Bank Rate to be hiked until late next year, in August this year, the Bank Rate was lifted to 0.75%. 

2) A negotiated Brexit which includes a political declaration supporting a soft-Brexit. 

3) Defeat of a Brexit motion in parliament causes the government to fall, paving wave for a general election and/or a second referendum and potentially no Brexit.

Today’s much awaited Federal Reserve policy meeting will set the tone for markets heading into 2019. Expectations for further Fed rate hikes, on top of the eight that have already taken place since December 2015, have been scaled back significantly in recent weeks. A rate rise is still expected today but the probabilities given to hikes further out has been scaled back significantly. Markets now give less than a 40% probability to even one rate hike next year.

However, the quieter sentiment on the markets has got one major advantage. For all those who may not have hedged their GBP risks yet, the current situation provides a reasonably attractive entry level. 

OTC outlook: Positive bids are observed in the GBPUSD risk reversals of short-term tenors. While positively skewed implied volatilities of 3m tenors still signal bearish hedging sentiments. To substantiate this downside risk sentiment, risk reversals have also been bearish.

We reckon that the sterling should not suffer like before, but, one should not disregard Fed’s hiking cycle on the other hand. The market has always ignored the fact that all the current BoE interest rate moves are due to a favourable result of the Brexit process.

Both the speculators and hedgers of GBPUSD are advised to capitalize on the prevailing price rallies for bearish risks and bidding theta shorts in short run (1m IVs) and 3m risks reversals to optimally utilize delta longs.

Strategic Options Recommendations: On hedging grounds, fresh delta longs for long-term hedging comprising of ATM instruments and OTM shorts in short-term would optimize the strategy.

So, the execution of hedging positions goes this way: Short 1m (1%) OTM put option (position seems good even if the underlying spot goes either sideways or spikes mildly), simultaneously, initiate longs in 3m ATM -0.49 delta put options. A move towards the ATM territory increases the Vega, Gamma and Delta which boosts premium.

Thereby, the above positions address both upswings that are prevailing in short run and bearish risks in long run by delta longs.

Currency Strength Index: FxWirePro's hourly GBP spot index is inching towards 14 levels (which is mildly bullish), and hourly USD spot index has bearish index is creeping at -77 (bearish) while articulating (at 10:16 GMT). 

For more details on the index, please refer below weblink: http://www.fxwirepro.com/currencyindex