FxWirePro: Spotlight On BoE’s Easing Measures And Sterling’s OTC Outlook & Hedging Strategy

In addition to the package of measures announced at last week’s unscheduled policy meeting, the Bank of England’s Monetary Policy Committee has sanctioned further easing measures at an emergency meeting. These included:

1. A further reduction in UK Bank Rate, this time by 15bp taking it to an all-time low of 0.1% - the Bank of England’s view of the effective lower bound.
2. A resumption of its QE programme where a further £200bn of assets will be purchased, financed by the issuance of central bank reserves. This will take the size of the Asset Purchase Fund up to £645bn and will primarily comprise of purchases of UK government bonds, with some non-financial investment grade corporate bonds also to be bought.
3. An enlargement of the recently announced SME Term Funding Scheme (TFSME).

Given that the Bank of England announced a ‘big package’ of measures at its emergency meeting last week and was likely in the midst of its regular policy update timetable – that was due to end on the 25th March with an announcement on the 26th – the big question is why now? Based on the accompanying statement, the main reason is attributed to the recent deterioration in gilt market conditions.

OTC updates: GBP will likely take its directional cue from the read-through to BoE’s rate cut whereas the size of the move will be augmented or moderated by the government’s broader policy platform, this is factored-in GBP’s FX options market. 

Please observe 3m GBP skews that has stretched towards negative territory, hedgers have shown interests for bearish risks as you could see more bids on OTM Put strikes. 

To substantiate the downside risk sentiment, risk reversal numbers have still been signalling bearish hedging sentiments in the long run. Accordingly, we advocate the diagonal options strategy on both hedging and trading grounds. 

Though the underlying spot FX is showing some resistance to the prevailing bearish streaks, these rallies seem to be momentary. Hence, this is right time to write deep OTM put options.

Strategy (Debit Put Spread): Capitalizing on the above factors, it is prudent to deploy diagonal options strategy by adding short sterling via a limited loss tail hedge: Stay short a 1M/2W GBPUSD put spread (1.15/1.28), spot reference: 1.1870 level. Courtesy: Sentry, Saxo & Lloydsbank