Traders in the options market are preparing for the British pound to fall by as much as 8% more, following a dramatic selloff in UK markets last week. Concerns over the country’s fiscal health and the economic impact of high borrowing levels continue to weigh heavily on the currency.
Demand for options contracts betting on a weaker pound has surged, with many traders anticipating the pound could dip below $1.20 — almost 2% lower than its value on Friday. Some are even wagering that sterling could fall below $1.12, its lowest level in over two years.
Fiscal Woes Weigh on UK Currency
The pound was the weakest performer among major currencies last week, reflecting broader concerns about the UK’s economic outlook. Worries about the impact of Donald Trump’s policies, persistent inflation, and high levels of national borrowing led to a global market retreat, with UK assets at the center of the turmoil. Investors argue that the market is underestimating the Bank of England’s need for rate cuts to stimulate the economy, further pressuring the pound.
“The path of least resistance is lower at this juncture,” said Jamie Niven, a fund manager at Candriam. “Limited pricing in of Bank of England cuts, combined with fiscal concerns, are negative for sterling.”
UK Assets Hit Hard by Rising Yields
The pound’s decline mirrored the poor performance of other UK assets last week. Yields on 10- and 30-year government bonds (gilts) surged by a quarter percentage point, and the FTSE 250 stock index saw its biggest drop since mid-2023. This triggered comparisons to the market chaos following former Prime Minister Liz Truss’s controversial mini-budget in 2022, although the magnitude of this week’s moves has been less severe.
However, demand for pound options last week exceeded even the levels seen during the 2022 mini-budget crisis and the 2016 Brexit referendum, signaling heightened market anxiety.
Surge in Options Activity Reflects Market Fear
According to Mimi Rushton, Barclays’ global head of currency distribution, there was a 300% increase in inquiries for sterling options as hedge funds bet on further declines. The surge in activity has made trading conditions more volatile and difficult, she noted.
At the start of 2023, contracts betting on the pound strengthening against the dollar were in favor. However, last week’s spike in bond yields triggered a sharp reversal in sentiment, with traders now leaning heavily toward further weakness in sterling.
“Demand for longer-dated options remains elevated, suggesting the market isn’t done with this theme yet,” said Tim Brooks, head of FX options trading at Optiver.
Strong U.S. Jobs Data Adds to the Pressure
The pound faced additional downward pressure on Friday following stronger-than-expected U.S. jobs data. The report raised expectations that the U.S. Federal Reserve would hold off on aggressive interest rate cuts, strengthening the dollar. As a result, the pound fell by 0.8%, settling at $1.2207, its lowest level since November 2023.
Mixed Forecasts for the Pound
Strategists surveyed by Bloomberg expect the pound to recover slightly, forecasting it could rise to $1.26 by the end of the quarter. However, many of these predictions were made in December, before the recent volatility. In light of the sharp swings in the currency market, some banks have adjusted their outlooks.
Meanwhile, UK bond markets saw a slowdown in the pace of yield increases towards the end of the week, after a sharp 11 basis point spike in the 10-year yield on Wednesday. The yield settled at 4.84% on Friday, up 25 basis points over the course of the week.
UK Officials Seek to Calm Market Fears
UK officials have attempted to reassure investors, with Treasury Chief Secretary Darren Jones stating that the gilt market is functioning in an “orderly way.” Major investors, including Pacific Investment Management Co., Franklin Templeton, and Fidelity International, have reaffirmed their bullish positions on UK debt.
Deutsche Bank Strategist Suggests Further Weakness for Sterling
Despite the reassurances, some analysts remain pessimistic about the pound’s future. Shreyas Gopal, a strategist at Deutsche Bank, recommends betting against the pound, suggesting it will continue to weaken against a range of major currencies, including the euro, dollar, yen, and Swiss franc.
“There’s further to go in the recent pound weakness,” he said. “It’s time to turn short.”
As UK fiscal challenges persist and global market conditions remain volatile, traders are bracing for continued uncertainty in the value of the pound.
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