Is the British Pound about to drop another 8%? The UK is mired in a fiscal crisis, and traders are frantically shorting
The pound faces an 8% risk of further decline due to market sell-offs caused by fiscal difficulties. The options market shows a surge in demand for contracts betting on the pound falling below 1.20 against the dollar, with some traders even predicting a drop below 1.12. Limited expectations for interest rate cuts, combined with high borrowing levels and inflation concerns, further increase pressure on the pound. Last week, the pound fell alongside other assets, with options demand exceeding levels seen during the crisis and trading volume unusually high
According to the Zhitong Finance APP, options market traders are preparing for a scenario where the British pound could drop another 8%, as the fiscal turmoil that triggered a painful sell-off in the UK market last week has put pressure on the pound.
According to data from the Depository Trust & Clearing Corporation (DTCC), there is significant demand for contracts betting on the pound falling below 1.20 against the US dollar, nearly 2% lower than last Friday's trading price. Some traders are even betting that the pound will drop below 1.12 against the dollar, which would be the lowest level in over two years.
Last week, the pound proved to be the weakest currency among developed nations, as concerns over Trump’s policies, sticky inflation, and high borrowing levels triggered a global retreat—UK assets were at the center of the turmoil. Investors indicated that the market is underestimating the necessity of interest rate cuts to stimulate the economy, which is another source of potential pressure on the pound.
Jamie Niven, a fund manager at Candriam, stated, “At this critical moment, the path of least resistance is downward. On one hand, expectations for the Bank of England to cut rates are very limited, and fiscal concerns are also unfavorable for the pound.”
Last week, as the yields on 10-year and 30-year UK government bonds surged by 25 basis points, the FTSE 250 index recorded its largest decline since mid-2023, with the pound falling alongside other UK assets. This has led to comparisons with the market crash following Liz Truss's disastrous mini-budget announcement in 2022, although the severity of these measures cannot be compared.
Nevertheless, demand for pound options last week exceeded levels seen during the crisis and even surpassed those around the 2016 Brexit referendum.
Mimi Rushton, head of global currency distribution at Barclays, noted that due to hedge funds flocking to bet on further weakness of the pound, inquiries regarding pound options trading increased by 300%. She mentioned that the unusually high trading volume has made some trading conditions “more challenging.”
Earlier this year, contracts betting on the pound strengthening against the dollar were also favored. However, DTCC data shows that the surge in bond yields last week triggered the most severe sentiment shift in over two years.
Tim Brooks, head of forex options trading at Optiver, stated that demand for “longer-term options remains quite high, indicating that the market has not yet finished with this theme.”
Last Friday, after stronger-than-expected US employment data raised expectations that the Federal Reserve would not be able to cut rates significantly, the pound fell again. The dollar climbed, and the pound fell 0.8% against the dollar to 1.2207, the lowest level since November 2023.
Strategists surveyed had previously expected the pound to rise to 1.26 against the dollar by the end of this quarter, although most of these predictions were made last December. Given the extreme volatility in the currency market, some major banks changed their forecasts last week In the bond market, after a surge of 11 basis points in the 10-year Treasury yield last Wednesday, the pace of yield increases slowed in the latter half of the week. This resulted in a yield of 4.84% last Friday, marking a rise of 25 basis points over five days.
UK officials attempted to reassure the market. Treasury Chief Secretary Darren Jones stated that the UK government bond market is operating in an "orderly manner." Firms including Pacific Investment Management Company (PIMCO), Franklin Templeton, and Fidelity International expressed their continued optimism for UK government bonds.
Deutsche Bank strategist Shreyas Gopal, however, is less optimistic about the outlook for the pound. He suggested reducing positions in the pound against a basket of other major currencies, including the euro, dollar, yen, and franc.
He stated, "The recent weakness of the pound has room for further decline," and it is time to "turn bearish."
