A trade idea which I think may be quite enticing to partake in, in Q1 2016 would be to long GBP/NZD. The underlying core theme behind the idea is that we might be witnessing a repricing of the BoE's stance on monetary policy, now that the Fed has hiked. A short point was made in my previous post in regards to the co-relationship of UK and US rates. Looking at both economies, we can see that at the general level, the UK does not look to far off from the US in terms of positive economic performance. The chart on the left shows the downward trend in unemployment in both the US and the UK, with the UK unemployment rate at 5.2%, while the chart on the middle depicts average weekly earnings growth of both economies. The BoE has highlighted the recent flattening of the growth in earnings from a high of 4.0% YoY, but current levels still are largely lock-step with rates of wage growth seen in the US. The Months to 1st Rate hike gap with the Fed and BoE still are still at 2015 highs and there's little reason as to why this gap would further increase to a gap more than 10 months. Judging from general media opinion and consensus forecasts, the risk that the BoE comes out more hawkishly than the market expects is still underpriced, and thus is a trade I'd like to be on the side of. Inflation expectations from surveys and 5Y breakevens, remain anchored, additionally telling that the inflation outlook may not prove to be as poor as many think.
Ok so why the GBP/NZD cross? One of the reasons of not playing the standard GBP/USD pair, is that I honestly have a low conviction in regards to what the USD will do (though have a view that we might pullback given historical comparisons of previous hikes - though of course there's the argument that 'this time it's different'). The GBP/NZD pair is trading cheap in comparison to short-term rates, diverging quite a bit since early October. If the pair attempts to recouple with rates, this implies a move back to 2.350+. Using the RSI as a technical overlay, we can see that there's a clear positive divergence in the oscillator, which may be a sign of a bottom. On the NZD side of the trade, the Kiwi economy is actually doing quite alright, and the recent rebound has been a staple trade in Q3 2015 for me vs the EUR (even if the EURNZD no touch didn't expire ITM which still somewhat annoying, as I probably should have tried to lock in MTM gains in hindsight). It is however diverging from the UK at least on the unemployment side, with the unemployment rate rising in 2015, whereas it has continued to fall in the UK throughout 2015. The NZD TWI has been rising as of late, and may prove to be of concern to the RBNZ, in that the market has perceived the latest statement as hawkish for the inflation outlook.
There's a Credit Suisse chart I had in the summer of EMFX and Credit performance around US rate hikes, and has shown outperformance during Fed hiking cycles. Despite such a historical analogue which may definitely be useful for comparative analysis, we can somewhat argue that this time there are differing characteristics of the current period with commodity prices falling like there's no tomorrow, and EMFX, and select EM nations' equities/bond markets under pressure. Sure, there's no doubt within the EM space there could be relative outperformers (like India for example) but in general, if EM pressure is to continue, GBPNZD would benefit, in that the NZD leg would suffer. The chart below overlays the JPMEMFX index (inverted), and we can see that GBPNZD tracks it somewhat well from 2013. There's a decoupling between the relationship from November 2014, to March 2015, but we can see that the pair recoupled gradually. So if there are shocks to EM, the GBPNZD could be expected to benefit. In addition to this, because the NZD is a carry sensitive currency, adverse developments in risk sentiment can precipitate a sell-off in the currency.
In terms of how to construct a trade around this, a 3m GBPNZD digicall could work with a conservative strike at 2.3200 (still need to price this, and would prefer to enter one after holidays). The 5-month rolling monthly ATR for the pair stands at 600 pips (let's assume this drops a bit as well with holidays trading), so the assumption that the pair could move to 2.3200 from spot currently near 2.200, a 1000 ish pip move is definitely something within the norm for a span of 3 months. The NZD still over the long run, tracks commodity prices, and if we do get a bounce in Q1, a 'hedge' might be to long NOK, where the Nordic economy ex-Oil is actually faring alright. On a more active 'hedge', I'm looking to keep a close eye on spot around RBNZ key event risks to see if there are any substantial NZD-bullish risks to trade long intraday off of.