By Naomi Rovnik, Nell Mackenzie and Yoruk Bahceli
LONDON (Reuters) – Investors who enjoyed a brief rally in long-dated U.K. markets are facing a series of losses as slumps in the pound, government bonds and stocks feed off each other and put Britain at risk of a wave of attacks on hedge funds.
As global borrowing costs rise in a trend led by the U.S. government bond market, Britain’s high-debt, low-growth economy, which just months ago appeared to be rebounding from years of post-Brexit gloom, is now seen as vulnerable to capital flight.
Traders now expect months of volatility for the pound, which ended 2024 as the best-performing major currency against the dollar on optimism that Labor’s landslide victory in July’s election marked the end of years of political instability.
This creates a negative feedback loop by reducing interest in British stocks, which now face new currency risks, and casts doubt on the Bank of England’s interest rate cuts, threatening already stagnant economic growth as the national debt burden rises.
There are signs that the pain will last. Options trading data and evidence from hedge fund industry insiders and securities trading desks suggest that speculators have piled into bets against the pound and the British currency.
“I don’t think it’s going to end any time soon,” Brandywine Global fixed income equity portfolio manager Jack McIntyre said of the UK pullback, noting investors remain scarred by the 2022 gilts-UK currency crisis sparked by former prime minister Liz Truss. – budget.
The US-based asset manager said it took exposure to British plantations on the basis that the asset would benefit from a rate cut, but hedged that with contracts that profit if the pound, now 2.5% lower against the dollar this month , keep falling.
BUYERS’ STRIKE
Just a few months ago, British markets shone as a beacon of stability amid political chaos in France and looked set to recover from a long period of government turmoil, currency volatility and foreign investor shunning.
Market moves in January “refocused the minds of many around the world on Britain, its economic and financial condition,” said Mario Monti, the economist who was tapped in 2011 to lead Italy, which was facing financial implosion.
The UK’s long-term borrowing costs have hit 27-year highs, and the domestic stock index has fallen almost 6% since August. The pound’s volatility buying hedge gauge is near its highest since March 2023.
“The U.K. is more vulnerable to a post-Brexit buyer strike because it is a less key holding for many global investors and has a less obvious growth story,” Krishna Guha, vice president at U.S. investment bank Evercore ISI, said by email.
Bank of America this week warned of a “significant deterioration in the situation that could lead to currency (and) volatility in the pound, which in turn would dampen bullish sentiment and negatively impact equities.”
‘THE WEAKEST LINK’
Rising debt costs have stymied Finance Minister Rachel Reeves’ plan to revive growth through public investment, while sterling’s fall has put the BoE in a bind in case a rate cut pushes the currency even weaker, raising import-cost inflation.
“As a low-growth economy with relatively high interest rates, the UK is sailing very close to the wind,” said UBS head of G10 FX strategy Shahab Jalinoos.
“In a world of rising interest rates, trading is like the weakest link.”
The political mood is also feverish again, as polls show a rise in the popularity of Brexit campaigner Nigel Farage’s Reform Party, while Labor leader Keir Starmer’s ratings have fallen.
“The political instability that we thought we were done with when the (July) election came back,” said Janus Henderson director of European equities Tom Lemaigre.
He expected renewed volatility in the pound that could deter foreign investment in British stocks exposed to currency risk.
HEDGE FUNDS CIRCLE
“Hedge funds are now selling pounds and gilts,” said Artemis Fund Management portfolio manager Liam O’Donnell.
“It’s active money, active short selling coming into the market,” he added, referring to the practice of borrowing securities in hopes of selling them and then buying them back cheaper.
Brokers are charging fees of up to 30 basis points (0.3%) to lend gilts to speculators, almost double the 10-year average, reflecting increased demand from short sellers, S&P Global Market Intelligence data showed.
Trend-following hedge funds called CTAs mainly bet against the pound and British currencies, JPMorgan said in a client note.
Lagging UK growth has lured a “subset” of hedge funds into short selling sterling, said Tom Finnerty, senior analyst at Franklin Templeton Investment Solutions.
Even so, some see the wave of sales as an opportunity.
“I think now the pessimism is extreme,” said Mario Unali, head of investment advisory at hedge fund investor Kairos.
In the next few months, he intended to be exhibited in Great Britain, he said.
