Pound’s Dramatic Week Leaves Traders Skeptical of Quick Recovery

  • Investors spooked by 6.1% flash crash pessimistic on Brexit
  • Pound seen dropping to $1.20 by year-end by Janus’s Myerberg

After a dramatically dismal week for the pound punctuated by a flash crash in Asia, traders doubt it will shake off its tag of the worst-performing major currency in 2016.

They’re negative because sterling is held hostage by the prospects of a hard Brexit and its impact on the U.K. economy. That adds to concern over how the third-most traded currency pair, the pound-dollar, could crash and bounce back with no apparent explanation beyond speculation that computer-driven trading was to blame.

The pound’s weekly decline against the euro was the worst since 2009, beating the 3.4 percent drop during the week when Britain voted to leave the European Union this past June. The selloff Friday, when investors were spooked by a 6.1 percent plunge in two minutes, only hastened a decline that kicked off earlier in the week when Prime Minister Theresa May signaled a crackdown on immigration should take precedence over access to the bloc’s single market.

“There’s not a lot of upside” for sterling, said Ryan Myerberg, a portfolio manager at Janus Capital in London. “Extreme moves like the one we had overnight on Friday are obviously surprising, but there is a context of a country that is having a lot of political issues. We have a lot of uncertainty around what’s going to happen with Brexit and the relationship with Europe.”

Sterling slid 1.4 percent to $1.2434 on Friday. The drop of 4.2 percent in the week was the most since that ending June 24, when the Brexit vote results were published. The pound weakened 3.8 percent to 90.01 pence per euro since Sept. 30, its largest weekly depreciation versus the single currency since January 2009.

Hedge funds and other large speculators increased their net-short futures positions in the pound to a record, according to data going back to 1992, the Commodity Futures Trading Commission said this week. A short futures position profits from a decline in the currency.

“The pound is still in the process of trying to establish a new equilibrium following the flash crash overnight,” which has “reinforced negative sentiment towards the currency” driven by concerns over a so-called hard Brexit, said Lee Hardman, a foreign-exchange strategist at Bank of Tokyo-Mitsubishi UFJ Ltd. “It will take time after such destabilizing price action.”

As strategists and investors speculated on what sparked the crash during Asian hours, the currency rebounded from a low of $1.1841, swinging more than six times as much as its one-year median move.

Tough Divorce

Signs that the divorce talks -- and terms -- of Britain’s planned exit from the world’s largest trading bloc were likely to be bitter emerged in the annual Conservative party conference that ended Wednesday. An aide to Brexit Secretary David Davis outlined what he called red lines for the U.K. They included giving up free movement of labor among others. In response, European leaders signaled a growing reluctance to grant any special terms to post-Brexit Britain.

“The pound is in a free-fall and nobody wants to touch it right now,” said Aurelija Augulyte, a strategist at Nordea Markets in Copenhagen. “But parity calls emerge, so the bottom must be near.” Augulyte predicts the pound will tumble to $1.20 and recover to $1.27 in three months.

As politics take center stage for the currency’s future and with less than six months to go before the U.K. government has said it will trigger the EU’s Article 50 to begin its withdrawal, investors question whether the currency has found its floor yet.

Friday’s flash crash-fueled slump on the pound has made the possibility of a historic $1 level more real, with a Bloomberg forecasting model based on implied volatility showing about a 5 percent chance of it happening within a year.

“The fact that you don’t get paid to own sterling, with rates at zero” and a “massive” current-account deficit are adding to the currency’s woes, says Myerberg. He’s keeping his forecast for the pound at $1.20 by year-end, but with “potential to go lower.”

— With assistance by Chiara Albanese

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