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Pound could find a floor at US$1.17 in overwhelmingly short market
THE pound's sudden surge on Thursday made one thing clear: after an almost 9 per cent tumble from the year's highs, it may now be close to a floor where value hunters are waiting.
In a market that's overwhelmingly short the currency, a further decline of about 4 per cent may tempt buyers back in, according to some strategists. Such a drop would take it to levels unseen since 1985.
For State Street Bank and Union Bancaire Privee, it's not yet time to make a bet on a pound recovery but further declines into the Oct 31 Brexit deadline could add to its appeal. Strategists at both institutions point to US$1.17 as a level that looks attractive to enter long positions, although that would depend on their verdict on the extent of the bad news behind the drop. Coutts & Co is already long sterling assets.
"It's been an incredibly popular trade to sell sterling - at a certain point, if everybody sold sterling, who else is there left to sell?" Monique Wong, a senior portfolio manager at Coutts & Co, said in an interview with Bloomberg Television's Matt Miller earlier this week.
The pound rallied more than 1 per cent on Thursday after French President Emmanuel Macron said he was "confident" that the two sides "could find something intelligent in 30 days" to resolve the Brexit deadlock. The remarks followed similar comments from German Chancellor Angela Merkel on Wednesday and prompted some optimism, even as both leaders warned the basis of the Brexit agreement couldn't be changed.
The UK currency was around US$1.2210 on Friday, compared with the year's high of US$1.3381 in March. A further drop of more than 4 per cent would take it past the October 2016 flash-crash low of US$1.1841.
Investors still need to be prepared for multiple risk scenarios, including a no-deal outcome, a renegotiated agreement and even a snap election in the UK that could boost the odds of a win for the opposition Labour Party under Jeremy Corbyn. Barclays Plc said this week that a no-deal situation looks "increasingly inevitable", making that its base case.
"If I saw a general election was called and cable was at US$1.17 post-Brexit, I would then go and implement a long position," said Peter Kinsella, global head of currency strategy at UBP. "I would not be buying if Corbyn was in government."
With just over two months to the Brexit deadline, the market is heavily short on the UK currency. Since Boris Johnson's appointment as Britain's Prime Minister, option bets for sterling losses have outweighed those looking for gains by a ratio of approximately 1.5:1, according to data from the Depository Trust & Clearing Corporation.
Pound puts with a strike below US$1.17 represent just 14 per cent of the total exposure. Asset managers and hedge funds also remain overwhelmingly short the currency, according to data from the Commodity Futures Trading Commission.
"You expect, on a no-deal scenario, for cable to get somewhere around US$1.05, US$1.10," said Timothy Graf, State Street's head of EMEA macro strategy for Europe. "If there's still a probability that doesn't happen, somewhere around US$1.15-US$1.17 looks a bit cheap." BLOOMBERG