Investors Positioned for Huge Sterling Selloff to Continue
Posted by hkarner - 13. Juli 2016
Source: The Wall Street Journal
The pound has already weakened dramatically, but foreign investors won’t buy U.K. assets if they think it will fall further
The pound’s dramatic fall since Britain voted to leave the European Union is its swiftest decline on record. But positioning in currency markets suggests most investors are ready for more to come.
The latest data from the U.S. Commodity Futures Trading Commission indicates that investors believe the pound will continue to fall even after its 13% plummet against the dollar since June 23. They join the chorus of analysts also predicting sterling’s journey south is not over.
Some classes of money manager actually increased their net short position in the first week of July, despite the major decline in the last three weeks.
Sterling fell from $1.50 on the evening of the U.K.’s vote to leave the European Union, to below $1.30 for much of the last week.
Asset managers now have 81,986 more short contracts than long contracts, meaning that they generally expect the currency to continue falling. That’s the largest net short position since the end of March, despite the collapse in the pound since then.
Leveraged money, a category largely made up of hedge funds, also recorded a growing net short position. The category actually had a net long position in the final week of May, a few weeks before the vote, but now has 29,819 more short than long contracts.
There’s a common view in markets that extreme positioning — where investors overwhelmingly agree on the direction a currency will move — means that it’s unlikely to move much further in that direction. In this idea, there is nobody else taking the other side of the trade so prices can’t move further. If, for example, everyone believes a currency will fall, who will buy it at its current price?
But HSBC currency strategists believe that logic is wrong.
“Whilst extreme positions are likely to be followed by sharp price moves, this price move may be in either direction,” the research note adds. “Positioning tells you about future volatility, not about future direction.”
Many politicians who had argued for Brexit say that a cheaper pound is good news for the U.K., given that it makes the country’s exports more competitive. But if investors just aren’t sure how cheap the pound will get, they may well hold off on acquiring U.K. assets, to avoid making paper losses.
In one example, for a U.S. investor, British property has effectively got 13% cheaper since the end of voting on June 23. But if Deutsche Bank’s gloomy forecast for the pound is accurate, sterling will drop another 12% by the end of the year, and any investor buying now would make a mark-to-market loss.
Likewise, a further fall in the pound would reduce the value of dividends paid out by companies, or of the coupons offered on bonds.
Despite the drop in the pound, the continued uncertainty around the U.K. political and financial outlook “is a key reason to suppose that (sterling) faces intermittent and potentially accelerated downwards pressure in coming months,” said Paul Meggyesi, foreign exchange strategist at J.P. Morgan, in a research note.
“Dramatic though [sterling’s] collapse on Brexit night was, it was never likely to mark the low point.”