The Pound’s Record New-Year Rally Veils Brexit Concerns

Updated on
  • Investors are focusing on short term, says Algebris’s Gallo
  • Leveraged accounts have biggest pound long position since 2014

The pound’s strongest start to a year on record has the bears running for cover.

Algebris Investments money manager Alberto Gallo abandoned his negative outlook on sterling to go long the U.K. currency versus the dollar in the fourth quarter of last year. BlueBay Asset Management LLP dropped this month its own pessimistic call to turn neutral. The pound surged 5 percent versus the dollar in January, its best run in the first month of a year in Bloomberg data going back to 1971, and 1.1 percent versus Europe’s shared currency.

Sterling rallied against the greenback in the past week to levels unseen since Britain voted itself out of the European Union in June 2016, driven by a combination of optimism about a smoother Brexit and broad dollar weakness. Leveraged accounts’ long positions on the U.K. currency have steadily risen since September, reaching the highest since 2014 last week, CFTC data show.

“Market focus has moved onto the transition period so the downside didn’t materialize,” Algebris’s Gallo said, referring to hopes for a grace period after the U.K.’s official exit from the EU, to smooth the divorce and help businesses prepare to trade under a new regime. Still, “I believe investors are confusing the transitional deal with the final one or simply focusing on the short term.”

HSBC Holdings Plc this week raised its year-end predictions for the pound to $1.34 from $1.26 previously, and to 0.93 per euro from 0.95. UniCredit SpA boosted its end-2018 sterling projection by 8.8 percent to $1.49 and that for the end of 2019 by 7 percent to $1.52. The U.K. currency traded at $1.4199 at 3:55 p.m. in London on Wednesday, after rising as high as $1.4345 on Jan. 25.

Bullish Shift

Some forecasters including ING Financial Markets are now calling for the pound to break above $1.50 by the end of this year, as factors including the rising long positions at leveraged funds suggest a positive shift in pound sentiment. The Citi Economic Surprise Index for the U.K. has held above zero since October as economic data including jobs figures have beaten expectations.

While Algebris’s Gallo abandoned the pound-bearish call after the currency rallied, he remains bearish on the U.K. overall, pointing to issues including rising deficits. Government estimates leaked this week suggested the economy will be worse off in every likely Brexit scenario. Buzzfeed cited documents saying long-term economic growth will suffer in any of the three most probable situations modeled, ranging from a “no-deal” outcome to a so-called soft Brexit.

BlueBay is waiting to see how the Brexit deal takes shape before betting on sterling in either direction, according to Mark Dowding, co-head of investment grade and a senior portfolio manager.

Currency derivatives are showing increased confidence in sterling. Three-month pound call options against the dollar rose above puts this month for the first time since 2009, with the so-called risk reversal rate peaking at 0.19 on Jan. 22.

— With assistance by John Ainger

(Updates prices from second paragraph.)
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