Pound's Fate Could Worsen as Investors See Multitude of Risks

(Bloomberg) -- Pound traders are faced with several scenarios as political turmoil surrounds U.K. Prime Minister Theresa May, and few look positive.

With this week’s events suggesting May’s Brexit plan doesn’t have strong support, investors now wonder what the premier’s next move will be if her deal is rejected in Parliament. May’s options include negotiating another deal with the European Union, holding a second Brexit referendum or even a general election, all as she faces the possibility of a no-confidence vote in her leadership.

Pound's Fate Could Worsen as Investors See Multitude of Risks

Any of these events would make reaching a divorce agreement between Britain and the EU by year-end extremely difficult and the pound could plunge to $1.20, according to Credit Agricole SA. BlueBay Asset Management and Aberdeen Standard Investments are among those who are similarly pessimistic on the currency’s outlook.

“The chance of the existing deal going through looks low,” said Mark Dowding, a money manager at BlueBay, which oversees the equivalent of $60 billion. “In the short term, a no-deal probability will rise.”

Sterling steadied Friday after dropping more than 2 percent at the peak of the U.K. political drama a day earlier. The pound could slide when trading resumes in Asia Monday should 48 Tory MPs submit letters of no-confidence in May. Her determination to stay as PM seemed to reassure the market in the short term, but longer term, the Parliamentary vote on the Brexit deal remains the key hurdle.

Brexit Pressure Valve

BlueBay’s Dowding is short pound versus both the euro and dollar, and is also short gilts on the view a significant collapse in the British currency would hit all U.K. assets. Sterling could reach $1.20 in a very short time if the deal doesn’t pass the lawmaker hurdle, said Credit Agricole’s Valentin Marinov.

“Given that the currency markets are the most liquid asset at investors’ disposal, shorting the pound could become the path of least resistance or, if you wish, the Brexit pressure valve, for many clients,” said Marinov, head of Group-of-10 currency strategy at the French bank. “This could mean that the drop toward $1.20 may take less than a week.”

The market has turned more bearish on the burgeoning U.K. political crisis, with demand for options to sell the pound climbing to the highest since 2016. James Athey, a money manager at Aberdeen Standard, which oversees $736 billion, said he exited his long position in pound-dollar Thursday morning as the political turmoil clouded the short-term outlook for the currency.

Woodman Asset Management AG’s foreign-exchange strategist Bernd Berg is even more negative on the pound. He sees it sliding almost 14 percent to $1.10, a level not reached since 1985, if a second vote on Britain’s membership of the EU is called.

“A second referendum would add a significant period of additional uncertainty, and if we head toward it, the pound will head to $1.10,” Berg said Thursday.

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