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GBP has been choppy but trendless this year on a messy interplay between Brexit politics and BoE expectations. Hopes that deterioration in the growth-inflation trade-off might prompt a rate hike as early as the end of this year initially boosted GBP, but these hopes evaporated when the BoE lowered its estimate of NAIRU.
Gilts continued to rally and outperform a cross market, majorly driven by position squaring and the rally in Euro rates.
All of this leaves GBP in limbo, albeit our forecast still assumes that a hard Brexit equates to a softer GBP over time. The timing and extent of such depreciation will depend in large part now on the performance of the economy rather than the politics of Brexit which are now reasonably settled. If we are wrong and the economy remains resilient through the summer, we will need to review the extent of GBP weakness, and indeed it is not inconceivable GBP could appreciate for a time if the BoE does indeed hike.
Hence, we stop out of our shorts in GBP versus USD 10-year swaps. The former has outperformed owing to rising political risk in Europe, and with little sign of a catalyst cheaper over the near term, we stop out here.
Rising risk-off sentiment in Europe has caused GBP rates to outperform, and with no clear catalyst for a reversal, we recommend stopping out of this trade.
Stop receiving fixed in $55mn notional of a 10-year (1/20/2027 maturity) USD swap and stop paying fixed in £43mn notional 10-year (1/20/27 maturity) GBP swap. P/L since inception: -17.6 bp.
