Risk of ‘Truly Unpredictable’ Pound Feeds U.K. Market Angst

Pound’s Worst Day in a Year Revives Emerging-Market Parallels

The U.K. pound is spiraling to multi-month lows and strategists are back to talking about it like an emerging market. 

Empty fuel pumps and grocery store shortages, faster inflation and the threat of higher interest rates are all adding to a sense of anxiety among market watchers, who say the pound is at risk of sharp declines. The currency fell to as low as $1.3422, the weakest since December, and already lost over 2% this month.

“The concern for macro investors is if sterling becomes a market that will become truly unpredictable,” said Jordan Rochester, a strategist at Nomura International Plc.

Risk of ‘Truly Unpredictable’ Pound Feeds U.K. Market Angst

The pound’s descent suggests it’s behaving more like an emerging-market currency, according to Adam Cole, chief currency strategist at RBC Europe. It’s far from the first time that analysts have made that comparison in recent years, though it’s a controversial one. 

Options suggest that cable could be in for further price swings as one-month implied volatility in the pair touched its highest level since April, decoupling from comparable gauges for other Group-of-10 currencies. 

Risk of ‘Truly Unpredictable’ Pound Feeds U.K. Market Angst

The developing-market parallels were first drawn amid the U.K.’s drawn-out exit from the European Union, and had largely gone away this year. Now strategists are bringing them back as the U.K. battles supply-chain chaos stemming from Brexit and the pandemic. 

Cole pointed to widening spreads in the rates market as a possible reflection of concern about the state of Britain’s finances, with the caveat that it’s too soon to know for certain. 

There’s also widespread disagreement among traders about what’s exactly causing the volatility, and obviously big differences between the U.K. and countries like Brazil and South Africa. For one, credit risk is a significant factor in the pricing on their debt, reducing their appeal in times of stress. Gilts, meanwhile, are typically seen as haven assets. 

The volatility of the pound, too, still trails these currencies. Some have said the recent sterling turbulence is being caused by leveraged funds holding concentrated bets.

Risk of ‘Truly Unpredictable’ Pound Feeds U.K. Market Angst

According to data from the Commodity Futures Trading Commission for week through Sept. 21, hedge funds were the most bullish on the pound in over two months. That was before last week’s hawkish BOE meeting, which may have prompted more bullish bets.

It’s important not to exaggerate the significance of the move, said Erik Norland, senior economist at CME Group. “The pound is still the world’s fourth-most widely used currency after the dollar, euro and yen,” he added.

Still, the sharp moves are keeping traders on edge. At the center of the U.K. market action is the BOE’s credibility in fighting inflation and keeping the economy on track. The BOE now sees inflation exceeding 4% and has signaled a rate-hike could come before the end of the year.

“Sterling investors appear to be signaling the view that an early rate hike, as signaled by BOE Governor Bailey, will worsen the growth prospects for the U.K.,” said Jane Foley, head of foreign-exchange strategy at Rabobank. 

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