FX traders had a slightly delayed reaction to news that UK PM Theresa May will trigger Article 50 next Wednesday but Cable is now sliding on the headlines. However, with speculative positioning already at record lows, many are asking “why would a long-term trader sell the pound now?”
As Bloomberg’s Mark Cudmore notes, it’s a question worth asking, because it seems that the vast majority of potential catalysts are skewed to be positive ones.
A lot of bad news/sentiment is priced. So much so that sterling now struggles to weaken on negative news. The Bloomberg Pound index made its multi-year low in October. Since then, there’s been a series of “higher lows” -– in November, January and March. The gradual uptrend is clear.
A market that can no longer fall on bad news is ripe to rally significantly if good news transpires.
Scotland may be dominating British news outlets but it’s irrelevant for markets right now. Not only was independence safely rejected less than three years ago, but there are far too many other factors to influence U.K. assets in the interim few years until the next vote.
There’s more than enough uncertainty around Brexit to deal with first.
That’s the thing though — we know that well. It’s been the most anticipated “disaster” in financial market history. Everyone has written about all the problems the U.K. will face in the coming years. I don’t see how Brexit can surprise negatively from here?
Kristin Forbes’ recent dissent on monetary policy has flagged the fact that the next move for U.K. rates is higher. A shift may not be imminent but, when it comes, it will be supportive for sterling.
The economic data continues to massively outperform consensus expectations. Bloomberg’s U.K. economic surprise index has been resolutely in positive territory since before Brexit. When will the doom-mongers just admit they were wrong, rather than constantly revising their Armageddon dates? Even the structural current-account deficit is starting to narrow thanks to the currency weakness.
However, not everyone agrees that the bad news is all out. Goldman Sachs overnight noted thate have now unquestionably entered the ‘lull’ period of the month after a flurry of important G10 data releases and central bank meetings.
As the dust settles, short Sterling remains one of our favorite views. That is true both from a near-term tactical standpoint (where we target 0.90 on EUR/GBP in 3 months, from 0.87 currently) as well as on a longer, more structural horizon.
While the BoE meeting last week took a more hawkish tone, our short Sterling view has never been about monetary policy. We think the imminent activation of Article 50 will trigger difficult trade negotiations, which is not properly priced into the currency. Moreover, while global growth and positive data surprises have been picking up, as shown by our CAI and MAP indexes, data in the UK have gone the other way. Sterling therefore offers perhaps the best divergence trade in the G10, particularly in this otherwise quiet period.
Looking at this week’s CFTC Commitment of Traders report, we are not alone in this view. The data show GBP net shorts reached a new all-time high, exceeding $8 billion for the first time since the data began in 1999. FX markets are always preoccupied with positioning, so the natural question is whether short Sterling is simply too consensus to be profitable.
It is of course true that the build-up in speculative shorts raises the potential for a violent short squeeze. However, in the quiet data period ahead, that seems like less of a risk than normal, in no small part because Brexit-related uncertainty is unlikely to decline significantly anytime soon.
In addition, in the past, we have actually found that stretched short positioning is a momentum signal on average for GBP/$. Specifically, when our Sentiment Index – measured as the percent of the way between max short (0) and max long (100) positioning over the last three years – is under 10, we find that GBP/$ tends to fall by 1.0 percent and 2.4 percent over the next four and eight weeks (Exhibit 1).