Traders Are Staying Short on the U.K. a Year After Brexit

  • Robeco reversed sterling bets on May’s hung parliament
  • Pound is biggest decliner versus greenback since Brexit vote

Timothy Graf, head of macro strategy for EMEA at State Street Bank, discusses the FTSE 100 being a derivative sterling trade, his call for the pound and his outlook for the BOE. He speaks on 'Bloomberg Markets: European Open.' (Source: Bloomberg)

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The risks are stacking up for investors a year after Britain’s historic vote to abandon the European Union: unstable politics, fears of stagflation and a currency nursing emerging-market-sized losses.

After sliding 15 percent, the pound’s performance is the worst among major currencies versus the dollar over the past year. While equities have basked in the global stock euphoria -- with a helping hand from the weaker sterling -- further gains this year are seen capped near current levels. And Brexit negotiations just started this week.

As a weakened government embarks on divorce talks set to last until 2019 at least, a survey by Barclays Plc showed investors rank the Brexit discussions second only to Italy’s political risk as the biggest threat to markets arising from Europe. Robeco Nederland BV turned short on the pound after a bungled election campaign by Prime Minister Theresa May resulted in a hung parliament and a surge of support for Labour leader Jeremy Corbyn.

Leon Cornelissen, Robeco’s Rotterdam-based chief economist, says he’s preparing for a third leader since the Brexit referendum.

“Long-term it’s impossible to predict what will happen and short-term it doesn’t look too nice,” Cornelissen said in an interview. “There’s a risk the government collapses in coming months which isn’t necessarily pound-friendly -- and there’s still a material risk of a hard Brexit. This divorce settlement bill will be difficult.”

Since the Brexit vote, the FTSE 100 Index’s fortunes have waxed and waned in inverse relation to the pound. In local-currency terms, the exporter-heavy benchmark surged 17 percent in the year that followed, but in dollar terms, it hovers near levels seen just before the referendum results. The gauge is projected to end the year at 7,500, implying a gain of just about 0.7 percent from Wednesday’s close, according to the average of strategist forecasts compiled by Bloomberg.

The FTSE 250 Index of mid-caps -- seen as more reliant on the domestic economy than the larger gauge -- is up 13 percent in the same period, with most of its advance coming in 2017. In dollar terms, however, it’s down 3 percent.

Gavin Counsell, senior multi-asset fund manager at Aviva Investors in London, prefers emerging nations and Europe to his home market.

“We’re underweight in U.K. assets,” Counsell said in an interview. “The impact of the currency fall has started to push up inflation and we’re seeing real wages falling in the U.K. We’ve gone from one of the fastest-growing developed economies to one of the slowest.”

At least the slow-growth scenario is benefiting one part of the market: U.K. government bonds have made almost 7 percent for investors since the Brexit vote, compared with a 1 percent loss for German bonds and a small loss for U.S. Treasuries in the same period, according to Bloomberg indexes.

Gilts will probably continue to do well given “the probability that safe-haven demand stays strong and medium-term growth expectations remain impacted by concerns about what lies beyond over the next couple of years,” said John Wraith, the London-based head of U.K. rates strategy at UBS Group AG.

Meanwhile, currency traders can no longer look for help from a Bank of England moving to tighten policy in tandem with the Federal Reserve. As the demands of a shaky recovery win out over the need to cool inflation, Governor Mark Carney signaled this week he wasn’t in a hurry to raise interest rates anytime soon.

The pound dropped to a three-decade low in the aftermath of the referendum and lost more ground in a mysterious “flash crash” in October. Analysts in a Bloomberg currency survey forecast the currency to end 2017 at $1.27 and 88 pence per euro, not far from current levels. In the meantime, however, given that “sterling’s sensitivity to headline news will increase even further,” strategists at UniCredit Bank AG recommend “booking profits in EUR-GBP longs for now and staying on the sidelines.”

With a government in tatters and questions over whether U.K. leaders will pursue a “softer” break with concessions on trade and free movement of people, or a harder line, it’s not surprising traders sound flummoxed.

“A year ago, in our collective wisdom, the Brits voted to leave the EU,” Kit Juckes, fixed-income strategist at Societe Generale SA, wrote in a note to clients Friday. “I didn’t guess that a year later we’d have political chaos, Jeremy Corbyn would be ahead in the opinion polls, and the economic mood would be dire despite an unemployment rate that hasn’t been lower since I was 13 and Rod Stewart’s ’Sailing’ was on top of the pops.”

— With assistance by Sid Verma

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