Hedge funds are starting to doubt the pound’s rally will last much longer after a surprising run that’s made it the best Group-of-10 currency this year.
Money managers are cashing in on sterling’s gain of more than 3% against the dollar in 2023, as the good news driving it — mainly a stronger-than-expected economy that allowed for higher interest rates — is now seen as well priced in. Analysts say the Bank of England’s eye-popping upgrade to its growth forecasts last week raised the bar for positive data surprises, limiting room for further pound strength.
Leveraged investors scrapped a position that profits from a stronger sterling and turned the most negative on the currency since December 2021, according to data from the Commodity Futures Trading Commission for the week ended May 9. The change came just before the British currency hit the strongest against the dollar so far this year.
“The recent upwards revision to BOE forecasts moves the goalposts for a hawkish data surprise,” said Simon Harvey, head of FX analysis at Monex Europe. “A trimming of rate expectations and therefore a modest selloff in the pound seems a likely outcome from data releases.”
The pound was up 0.3% to $1.2492 as of 11 a.m. London time on Monday. It reached $1.2680 last week, the highest since April 2022.
The pound became a market darling this year after a slump in 2022 driven in part by controversial fiscal plans that spooked investors and pushed it to a record low. Since then, many of the bleak views for the economy haven’t come to pass and the BOE has scrapped its view the UK will suffer a recession.
All of the optimism, however, made some investors and analysts reassess. The positioning change by hedge funds — which are now net short on sterling at 6,858 contracts after being long for most of the year — has come alongside warnings from banks that the rally may be approaching an end.
Deutsche Bank AG last week recommended taking profit on the pound’s rally as it no longer offers attractive risk-reward, while RBC Capital Markets told clients on Monday to short sterling versus the dollar as markets’ expectations for interest rates are too aggressive.
Dominic Bunning, head of European FX research at HSBC Holdings Plc, is less pessimistic, partly because of the beaten-down expectations.
“I’m not in love with sterling in terms of an absolute story,” he told Bloomberg Television. “But what we are seeing is that the data is improving.”
“As long as we are seeing improvements in the trend, even if they’re modest, and as long as we’re seeing improvements relative to expectations, then that’s what’s key to keep seeing sterling grind higher, he added.
The BOE’s Monetary Policy Committee has already raised interest rates by 440 basis points to 4.5% in the current cycle and signaled more is possible to tame inflation. Money markets are pricing in 44 basis points of additional hikes through October, with no cuts coming into play until late 2024. That contrasts with expectations for the US Federal Reserve of about 67 basis points in reductions by the end of the year.
“The pound has been one of the surprising success stories so far this year,” said Valentin Marinov, head of G10 FX strategy at Credit Agricole CIB. “That said, we believe that the markets have got ahead of themselves and doubt that the MPC would be able to meet the hawkish market expectations.”
--With assistance from Dani Burger.
(Updates with comments from analysts starting in fourth paragraph, updates pound.)
Author: Ruth Carson, Aline Oyamada and Naomi Tajitsu