Pound Is Starting to Look Vulnerable After Hitting Two-Year High
(Bloomberg) -- The pound’s peer-beating rally got a fresh spur this week, but strategists from J.P. Morgan Private Bank, State Street Global Markets and Jefferies say those gains are looking increasingly fragile.
Most Read from Bloomberg
California’s Anti-Speeding Bill Can Be a Traffic Safety Breakthrough
New York City’s Transit System Plans $65.4 Billion of Upgrades for Grand Central, Subways
The Bank of England’s decision to hold interest rates on Thursday after the Federal Reserve delivered a jumbo cut the day before has lifted sterling to its highest since March 2022 versus the greenback. The pound is the best-performer in the Group-of-10 nations this year by a long stretch, with bets for further strength near the highest in a decade.
But a flagging UK growth spurt in the first half and a belt-tightening Labour budget in the cards for October mean there are clouds ahead — increasing the chances the BOE needs to ratchet up the pace of rate reductions to shield the economy, while removing a key pillar of support for the pound.
“I think the pound-dollar pair is living on borrowed time,” said Tim Graf, head of EMEA macro strategy at State Street. “Ultimately I think the pound will be lower against the dollar in three to six months’ time.”
And while other central banks ramp up their pace of easing, the BOE’s gradual approach to cuts means the pound has become a crowded destination for investors looking to capture higher relative returns.
Bets held by hedge funds and other leveraged funds in favor of the pound are hovering near their highest levels since 2014, after surging in July, according to positioning data from the CFTC. In the past month, institutional investors have become the most bullish on the pound in a year.
“It makes little sense to chase these moves higher over the near-term,” said Matthew Landon, global market strategist at J.P. Morgan Private Bank.
With sterling trading at $1.33 on Friday, HSBC Holdings Plc strategists say the currency’s current levels “look unsustainable.”
To be sure, risk reversals, a barometer of market positioning and options sentiment, show the market is favoring the pound over the next month, even as the trade becomes even more crowded. Traders say there’s continued demand for UK assets after the change of government.
But longer-term, there could be trouble.
As the UK currency approaches its strongest level in two years against the euro, hedge funds have been buying protection against further strength in the options market, according to currency traders familiar with the transactions, who asked not to be identified because they aren’t authorized to speak publicly.
Against the dollar, the pound is already trading around 2.5% above $1.30 — the level strategists in a Bloomberg poll saw it ending the year. While a further rise to $1.35 in the coming weeks is possible, Brad Bechtel, global head of foreign exchange at Jefferies in New York, said he’s “cautious” about a push higher.
“There may be a little upside left on the pound versus the dollar, but not too much,” Bechtel said.
Markets are pricing just 40 basis points of easing by the BOE through year end, much less than the 70 basis points of cuts seen for the Fed. A growing number of strategists see the risk of the BOE needing to cut more than the Fed next year.
The tax hikes and spending cuts predicted for what some are calling the UK’s “austerity budget” next month won’t help the economy in the short term.
Stephen Jen, chief executive officer at Eurizon SLJ Capital, says it could prompt the BOE to accelerate its rate cuts to cushion the demand shock, while hurting the pound.
--With assistance from Anchalee Worrachate and Vassilis Karamanis.
Most Read from Bloomberg Businessweek
©2024 Bloomberg L.P.