Pound Rally to 2020 High at Risk of Setback Even With Trade Deal

The pound’s best days may be behind it, even if the U.K. and European Union sign a trade deal.

Sterling rose as much as 1% to $1.35 on Thursday, touching its strongest level since December 2019. Yet the relative cost of hedging against a weaker sterling through year-end is the highest since April, according to a gauge of positioning and sentiment. And over the past month, hedge funds and other leveraged funds have increased short bets against the currency, data by U.S. Commodity Futures Trading Commission show.

Although some investors are still holding out for a payday when a trade agreement is signed, others are looking further out and say the U.K.’s economic outlook seems grim. For TD Securities, the damage the coronavirus continues to inflict on the nation’s domestic output -- which is more vulnerable now that the transition period from the EU is almost over -- is hurting the pound’s prospects. JPMorgan Chase & Co. estimates the currency will settle in the low $1.30s after the U.K. and EU strike a deal.

“The optimism around Brexit itself is fully priced in and a little too optimistic relative to where we go in the next couple of weeks,” said Mark McCormick, the global head of foreign-currency strategy at TD Securities. The investment bank’s 2021 outlook recommends selling the pound if an accord is signed.

Pound Rally to 2020 High at Risk of Setback Even With Trade Deal

Sterling had its best November since 2006, buoyed by the U.S. dollar’s drop and encouraging rhetoric from both the U.K. and EU on the possibility of a trade agreement. The advance came even as the U.K. suffered one of the biggest economic slumps among developed nations in 2020.

“It’s in part a weaker dollar story, though the pound is doing well across the board,” said Neil Jones, head of foreign-exchange sales to financial institutions at Mizuho Bank Ltd. “Market expectations for a deal as early as this weekend are prompting participants to pay up for sterling.”

And while the likes of Jack McIntyre, a portfolio manager at Brandywine Global Investment Management, is bullish on the pound into the year ahead in the hopes that Brexit will help the U.K. unleash its “animal spirit,” risk reversals and positioning data suggest otherwise.

Pound Rally to 2020 High at Risk of Setback Even With Trade Deal

If there’s a trade deal, “we accept the possibility that GBP could overshoot by a couple of cents, call it 1.35, but we see little value owning GBP for what could be a very-bounded, and potentially short-lived, relief-rally,” Paul Meggyesi, JPMorgan’s head of global foreign-exchange strategy, wrote in the bank’s 2021 outlook.

Economic Cost

Not only has the pandemic put Britain on course for its deepest economic slump since the Great Frost of 1709, the Office for Budget Responsibility estimates that the loss of output could be permanent.

Even if the U.K. enters a free-trade agreement with the EU, 4% would be shaved off the nation’s gross domestic product in the long run compared to where the economy would’ve been if Brexit never happened, the OBR forecasts. Failure to reach a deal, which means adopting World Trade Organization rules, would entail another 1.5% loss in GDP.

Brexit isn’t “favorable for an economy that hasn’t fared well through a pandemic,” McCormick said.

©2020 Bloomberg L.P.

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