Investors Bet Against Pound as Focus Returns to Brexit -- Update

By Caitlin Ostroff

Traders' sentiment toward the British pound has reached its lowest since the run-up to last year's election, as attention shifts from the coronavirus pandemic to stalled Brexit negotiations.

Hedge funds and traders using borrowed money to make speculative bets have taken the most positions against the pound since November, according to FactSet, signaling that they expect it to drop further.

The currency has weakened 1.8% against the dollar over the past 10 trading days, taking the decline this year to 5.6%. On Tuesday, one pound traded at $1.2521. Against the euro, the currency has slipped 6.4% this year.

The strength of the U.K.'s economic recovery will be determined by the country's future ties with the European Union, its largest trading partner, investors said. Britain officially exited the EU in January and both sides are hoping for a breakthrough by the fall toward a trade agreement. Without such a deal, the U.K. could face higher tariffs on goods starting next year.

"We still have this looming concern that we are potentially headed toward a no-deal Brexit," said Jane Foley, head of foreign-exchange strategy at Rabobank. "If we don't get any positive news, I think we can gradually drift a little bit lower on sterling."

Following a call with EU officials last week, Prime Minister Boris Johnson expressed optimism about an agreement. But a lack of details about the timing and specifics of what the new accord will entail has weighed on sentiment.

Speculation that interest rates may slip below zero are also damping the pound's prospects. The Bank of England has warned that the U.K. economy may shrink 14% this year, and policy makers have said they haven't ruled out negative rates.

Some investors see subzero rates as more likely if the U.K. doesn't work out a trade agreement with the EU by the end of the year. Markets are already pricing in the possibility of negative rates by February 2021, according to ING Bank.

Subzero rates would be "a function of the economy, and the economy is a result of the negotiations between the U.K. and the EU," said Petr Krpata, chief foreign-exchange analyst for Europe, the Middle East and Africa at ING. "If the U.K. is not doing well, potentially because of the U.K.-EU negotiations, the Bank of England would have to loosen monetary policy."

The U.K. also runs a current-account deficit and needs foreign investment to keep its financial system healthy. Negative rates could discourage investment in the U.K. and make the pound more vulnerable to a sharper selloff, some investors said.

Comments on Monday from Bank of England Gov. Andrew Bailey that the central bank would reverse its bond-buying program before raising interest rates -- a break from the previous governor's policies -- briefly pushed the pound higher against the dollar.

In the absence of further developments, the pound is likely to remain near current levels, analysts projected. The currency will remain sensitive to signs of the U.K.'s economic recovery and the trade negotiations, they said.

Meanwhile, the euro has gained 1% against the dollar this year. The European Central Bank has taken aggressive steps to shield the region's economy, including an expansion of its bond-buying program. Governments are also weighing additional steps, including issuing common debt or establishing a recovery fund, to help the most beleaguered member nations.

"The market is actually more upbeat on European growth than the U.K. It's less about the U.K.," said Geoff Yu, senior market strategist for Europe, the Middle East and Africa at BNY Mellon Markets. "Europe might be getting something right here."

In bond markets, the yield on the 10-year U.S. Treasury edged up to 0.708%, from 0.704% Monday. The yield on 10-year U.K. gilts edged up to 0.214%.

Write to Caitlin Ostroff at [e-mail]