Sterling defence
Options markets are flashing warning signals for Sterling. It’s no secret that the forthcoming Bank of England monetary policy decision later this week poses a risk for the Pound. However, there are risks mounting further afield. The local elections on May 7th are a material risk for GBP, for example, with traders concerned the ballot may impact domestic political stability.
Amidst a context of elevated general risk, not least thanks to the ongoing situation in Iran, traders have been paying hand over fist for downside GBP protection. Within EURGBP and GBPUSD, the lion’s share of positioning favours a weaker GBP. As a % of total exposure, expiries for month-end as well as into May see between 58% and 85% paying out upon the realisation of a weaker Pound.
This doesn’t necessarily mean that Sterling will fall from here. In fact, a short squeeze can cause greater than normal appreciations in the currency whereby the exit from existing positions drives demand into the undervalued asset that has been speculated against. It would be premature to say that Sterling is oversold, however, the longer that downside positions continue build and Sterling remains well bid on spot prices, the greater a reversal risk becomes. The base-case will remain for a weaker Pound, particularly upon any signals of a reluctance from the BoE to pre-emt or respond swiftly to inflation risks. However, an emerging tail risk of a GBP rally on the back of building short positions is emerging.
Discussion and Analysis by Charles Porter
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