Investors braced for pound to fall further
Investors are braced for the pound to fall further following Friday’s sterling flash crash, fearing continued volatility will result from the government’s “hard Brexit” stance.
The Bank of England has asked the Bank for International Settlements to study possible causes for Friday’s dramatic sell-off when the pound lost 6.1 per cent against the US dollar to reach a 31-year low of $1.1841 in just two minutes.
The rise of electronic trading, a “fat finger” trading error and poor market liquidity may have contributed to the flash crash.
But according to Jane Foley, forex strategist at Rabobank, the vulnerability of the pound has been enhanced by forecasts from many investors and economists that sterling was “teetering on the edge of further declines due to the risk of a ‘hard’ Brexit” that many fear could undermine the UK economy.
Sterling, the worst performer among major currencies this year, is under intense pressure after prime minister Theresa May last week gave her assessment of the upcoming EU divorce negotiations that was tougher than many investors had expected.
The market is now heavily positioned for the pound to fall further. Data released late on Friday by the Chicago Mercantile Exchange show net short sterling positions reached record levels on Tuesday.
“We are starting to see more discussion about what Brexit means and the possibility of ‘hard’ Brexit is putting pressure on the currency,” said David Zahn, head of European fixed income at Franklin Templeton Fixed Income Group. “Now it all comes down to the negotiations … This is raising a lot of uncertainty — and investors don’t like uncertainty.”
Rabobank pushed its sterling forecasts lower in response to last week’s falls and now expects the pound to drop to $1.18 by mid-2017, which would push the euro’s value up to 92p. Goldman Sachs said its three-month forecast is for the pound to fall to $1.20.
A contrarian view came from Stephen Jen, chief executive of asset manager Eurizon Capital, who said that while there were obvious downside risks for the pound, the currency was “grossly undervalued” and that its proper value was $1.50-$1.60.
Because the UK economy is driven by foreign investments to service its large current account deficit, sterling was going to suffer if those investments came into question, Mr Jen said.
“But I have full faith in the UK as an economy and a country, that it will make the best long-term decisions and the UK will thrive outside the EU,” he said. “I see a V-shaped trajectory for the pound in the coming quarters.”
Reverberations are also being felt across equity and bond markets as investors reconsider ownership of British assets.
The UK’s blue-chip FTSE 100 index rose last week as sterling weakness raised hopes of stronger exports.
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However the pound’s fall has knocked percentage points off record-breaking returns in gilts, sending the yield on 10-year bonds above 1 per cent for the first time in two months as currency weakness raises the spectre of bond return-sapping inflation and heavy losses for overseas investors.
In the year to date, gilts have provided investors with a total return of 13 per cent, according to Bank of America Merrill Lynch. Converted to dollars, that translates to a loss of 3.1 per cent. This uncertainty has encouraged bond strategists to advocate a focus on the short-term.
“With the medium-run effect of Brexit unclear, we prefer to trade nearer term dynamics,” said Mark Capleton, head of global inflation-linked research at BofA.