Pound Seen Stretched as Bullish Contracts Mimic 2011: Currencies

Not since early 2011 have investors set up as many trades seeking to profit from the pound’s advance as they have this month, and with the currency already having gained 14 percent from last year’s low, that’s making strategists nervous.

“We’re now becoming extremely cautious as to the amount of upside for sterling,” Ian Stannard, the head of European currency strategy at Morgan Stanley in London, said in an April 24 phone interview. In Stannard’s view, the market can only get less bullish from here, weighing on further gains. “Positioning is going to be a big factor” in how the pound trades, he said.

Bets by hedge funds and other large speculators on a rise in the U.K. currency exceeded those on a decline by 47,800 contracts as of April 22, Commodity Futures Trading Commission data show. The previous week’s net longs were 50,598, the most since reaching 52,572 in February 2011. That was just before a slide that saw the pound drop almost 7 percent against its major peers within five months, according to Bloomberg Correlation-Weighted Indexes.

While traders have gotten more bullish, strategists are more sanguine. The pound will drop 3 percent to $1.63 by the end of this year, according to the median estimate of about 50 analysts surveyed by Bloomberg. It reached a 4 1/2-year high of $1.6858 today amid a better-than-expected real-estate report and a wave of mergers and acquisitions activity, and was at $1.6807 as of 12:10 p.m. in New York.

Widening Deficit

The pound is unlikely to sustain an advance beyond $1.70, Stannard said. Morgan Stanley strategists forecast the currency will end the year at $1.63. Analysts at Deutsche Bank AG, the largest foreign-exchange trader, see it tumbling about 8 percent to the mid-$1.50s.

Even though a government report tomorrow may show a fifth straight quarter of growth in Europe’s third-largest economy, Bank of England Governor Mark Carney has played down the potential for interest-rate increases that would support sterling. Also, the widest current-account deficit in six decades contrasts with the U.S.’s improving trade balance.

Britain’s currency has climbed to the strongest level since November 2009 from a three-year low of $1.4814 on July 9, the week after Carney became the first foreign governor in the BOE’s 300-year history.

House Prices

House prices in England and Wales increased for a 15th month in April, rising 0.6 percent, a Hometrack Ltd. report today showed, while Pfizer Inc. said it’s interested in buying AstraZeneca Plc, Britain’s second-biggest drugmaker. That would increase demand for the U.K. currency needed to make the purchase.

“Overseas entities looking to buy U.K. entities and another surge in house prices, in part down to foreign-interest demand, are two key pillars for current and future pound strength,” Neil Jones, the head of hedge-fund sales at Mizuho Bank Ltd. in London, wrote in a note today. “A market cannot move without flows, and the flows are firmly buying the pound. I expect further buying.”

Sterling has posted the best performance against both the dollar and euro of 31 major currencies tracked by Bloomberg in the past six months, climbing 4.1 percent versus the greenback and 3.7 percent to 82.36 pence per euro.

Losing Steam

The pound has shown signs of plateauing this year, with the rate versus the dollar -- known as cable -- rising and falling in alternate months and strengthening just 1.5 percent since Dec. 31.

“While the rally in cable has been persistent, every episode of new highs has been followed by extensive backfill,” John Hardy, the head of foreign-exchange strategy at Saxo Bank A/S in Hellerup, Denmark, wrote in an April 25 note to clients. “The potential for new highs is limited.”

Saxo Bank predicts the pound will fall almost 8 percent to $1.55 by Dec. 31.

Broad demand for the dollar threatens to sap interest in the pound. The U.S. Federal Reserve is printing fewer greenbacks to buy bonds to reduce its monetary stimulus. At the same time, the deficit in America’s current account -- the broadest measure of trade -- is shrinking.

Brighter Outlook

“In the U.S., you have also a reasonably favorable growth picture and a favorable monetary policy outlook, plus an improving external balance,” Oliver Harvey, a London-based foreign-exchange strategist at Deutsche Bank, said by phone April 24. “There’s also some worrying reasons to suggest a structural decline in the U.K.’s current account. It should mean that sterling doesn’t outperform the dollar.”

In the minutes of its April 9 policy meeting, the BOE pointed out risks including a “recent widening” in Britain’s current-account deficit, which was 22.4 billion pounds ($37.7 billion) in the fourth quarter. It was 22.8 billion pounds the prior quarter, the most since 1951. The U.S. deficit narrowed to $81.8 billion in the fourth quarter, the smallest since 1999.

U.K. gross domestic product grew 0.9 percent last quarter, up from 0.7 percent in the final three months of 2013, according to the median estimate of 39 economists surveyed by Bloomberg before official data tomorrow.

While most strategists are reluctant to predict further gains in sterling, it has already surpassed their end-of-2013 forecasts for the first quarter. The pound rose 0.6 percent in the period to $1.6662, higher than the $1.61 median estimate in a Bloomberg survey.

‘Trending Higher’

“Sterling’s story is actually very different from other FX investments -- sterling is a major currency with an actual trend behind it,” Richard Cochinos, the head of Americas Group-of-10 currency strategy at Citigroup Inc., said in an April 23 phone interview. “And it’s trending higher.”

Citigroup, the world’s second-biggest currency trader, sees the pound climbing almost 3 percent to $1.73 by year-end.

Carney has revised the forward-guidance strategy he unveiled at his first Monetary Policy Committee meeting in August, when he signaled interest rates may rise when unemployment fell below 7 percent.

With the jobless rate tumbling to 6.9 percent in February, the BOE chief has instead put the emphasis on a broader range of economic measures, and told lawmakers in London on March 11 that any rate increases will be “gradual” and “limited.”

Consumer-price inflation remains below the BOE’s 2 percent target, further reducing the need to lift the main rate from a record-low 0.5 percent. In the past week, rates traders have pushed out bets on an increase in borrowing costs by a month to May 2015, according to ICAP Plc analysis.

Slower inflation in the face of faster growth is the main reason Royal Bank of Scotland Group Plc, Britain’s biggest publicly owned lender, sees the pound at $1.55 by year-end.

“The market has romanticized about the possibility that the BOE will become the first” major country “to hike rates,” Brian Daingerfield, a currency strategist at RBS in Stamford, Connecticut, said by phone on April 23. “The U.K. story right now is near-term positive, and significantly medium-term negative, for sterling.”

Before it's here, it's on the Bloomberg Terminal.