(Bloomberg) -- Sterling won new fans after the Labour Party’s election win. Now, currency traders are looking for reasons to stay optimistic as pressure mounts.
Investors were already cautious after the Bank of England’s first interest-rate cut since 2020 at the start of the month, but they didn’t foresee the weak US data and ructions in Japan’s markets that triggered a global rout in the days that followed. In the UK, anti-immigration riots and the prospect of tax hikes have dimmed the post-vote euphoria and done nothing to slow the pound’s tumble from a one-year high.
“The Labour honeymoon is likely over,” said Shahab Jalinoos, global head of currency research at UBS. “The pound has finally reacted to what has for some time seemed like excessive long positioning.”
Hedge funds, asset managers and other speculative market players pushed their net long wagers on the pound to an all-time high in July, piling in amid bets for a quieter political landscape after Keir Starmer came to power. Amundi SA and Loomis Sayles were among investors predicting the change in leadership would bring stability and an economic boost.
Those crowded derivatives positions have now flipped to the shortest since April. The pound is the worst performer among its Group-of-10 peers in August, threatening its position at the top of the pack for the year so far.
The currency steadied on Friday but remains on track for its fourth consecutive weekly loss versus the euro, the longest streak since December 2022. Traders will closely monitor UK inflation and economic growth data next week for further impetus.
Stability Dented
Bullish sentiment around UK politics has ebbed. Riots led by far-right activists are shaping up to dominate Starmer’s early days in office, while the likelihood of tax hikes will overshadow the October budget.
“We had a brief moment when sterling was the stability name in Europe,” said Lauren van Biljon, portfolio manager at Allspring Global Investments. “Perhaps the protests over the last couple of weeks have dented that in the longer-term.”
The unrest in the UK, coupled with the broader turbulence in global markets, has shown how the pound can’t pretend to anything like the dollar’s exceptionalism, according to van Biljon. The US currency’s role as a global haven asset means it can appreciate even during times of domestic uncertainty, she said.
The BOE’s pivot to rate cuts has also left the pound vulnerable to the violent recalibration in currency markets after Japan hiked rates last Wednesday. That’s reduced the UK currency’s comparative advantage as it crimps the potential returns for investors on sterling-denominated assets.
“The pound can’t be immune to these global forces,” said Paul Mackel, global head of FX research at HSBC. “Sterling is equivalent to castles made of sand, it doesn’t take much for its seeming resilience to be washed away.”
Equities, too, have reversed a move seen as evidence of investor optimism about the new government: The FTSE 250 Index, which tracks domestic stocks, has given up a lead over the more export-heavy FTSE 100 this year.
Still, one silver lining from the weaker pound is the potential boost to corporate earnings, which tend to have an inverse correlation to the currency.
--With assistance from Sagarika Jaisinghani.
(Added latest market moves, upcoming economic data in sixth paragraph.)
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