Brexit Overshadows Election Boost for Pound as Funds Skeptical

  • Allianz uses recent rally to short pound, foresees hard Brexit
  • Options signal sterling gains versus euro may be limited

U.K. Prime Minister Theresa May’s call for a snap election has done little to inspire confidence among portfolio managers on the pound’s prospects.

That’s in contrast to how markets initially reacted to the plan, with the pound rallying on the news and some analysts reconsidering their bearish calls on the currency on hopes for a smoother exit from the European Union. The risks from Brexit and a slowdown in the U.K. economy have Allianz Global Investors and J.P. Morgan Asset Management expecting the currency to head lower.

Polls show the vote in June will give May’s Conservative Party a larger majority as she heads into talks to leave the bloc, which she argues will improve her negotiating position. Yet this increases the probability of a hard Brexit, according to Kacper Brzezniak, portfolio manager at Allianz GI.

“We actually took the opportunity to short sterling after this recent rise,” said London-based Brzezniak at Allianz GI, which oversees assets totaling 480 billion euros ($524 billion). It sold at current levels and is targeting a fall to $1.24-$1.25, he said.

Extreme short sterling positioning was “a big factor” in triggering a surge in the currency since May’s April 18 election call, Brzezniak said, rather than a sea-change in sentiment on how Brexit talks pan out.

Options prices suggest that the pound might struggle to strengthen much more from here. The premium on one-month risk-reversal options, which expire close to the June 8 election, flipped in favor of euro calls from puts on April 26 as the French election yielded a market-friendly outcome for the common currency.

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Recent U.K. economic data has been far from encouraging with retail sales recording their largest decline in seven years in the first quarter and cracks appearing in public finances.

Staying Cautious

“We have for some time had a cautious outlook about the U.K., reflected in portfolios by an underweight position toward U.K. assets,” said Jaisal Pastakia, investment manager at Heartwood Investment Management, which has over 2.4 billion pounds of assets.

While U.K. equities are still a focus for J.P. Morgan Asset Management, Vincent Juvyns, global market strategist, expects the pound to remain under pressure while the Brexit negotiations play out. While the snap election might strengthen the Conservative Party’s position it will still be challenging to get to a mutually satisfactory agreement in the talks, he said.

“We have already lost quite a bit of time because we are already a month in into the two-year Brexit negotiation period and more than 20,000 European directives have to be renegotiated,” Juvyns said. “This is going to be very challenging.”

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