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  • Hedge funds and asset managers are positioned for the pound to outperform the dollar, but we think these positions could be vulnerable as too much positivity may be priced into the pound.
  • CME data on option strikes suggests demand for upside strikes in GBP/USD. UK May inflation data will prove critical and could be bearish for the path of the pound in the near term.
  • The FX volatility curve using CME options data suggests investors are no longer in “fear” mode.

The pound has been the best performing G10 currency over the past three months. It has rallied 3% against the dollar, which compares to the 0.7% of the euro and -4.8% of the yen. Strength has been driven by surprisingly strong economic data. Inflation has proven to be more persistent than expected, while the labour market has remained resilient. As a result, the Bank of England has been forced to continue raising interest rates, while markets have had no choice but to reprice an even more hawkish outlook.

On positioning, hedge funds have more than doubled pound net-longs from a month earlier (Chart 1). They are only second to Australian dollar net-longs. Elsewhere, they have flipped net-long on the Swiss franc, flipped net-short on the euro, and extended yen net-shorts.

Meanwhile, asset managers remain (just) net-long on the pound, reducing net-longs by 7,090 futures contracts (Chart 2). On the continent, they pared euro net-longs and marginally added to Swiss franc net-shorts. They also increased commodity currency net-bearishness.

Aggregating investor conviction, we find hedge funds and asset managers are both net-long the pound, and net-short the yen and Canadian dollar, but have conflicting views on the euro.

Macro Hive take: we hold the opposite view to investors on the euro. We think much of the bullish euro news is priced, the region’s manufacturing data is starting to turn down, and markets are over-pricing Fed easings. Therefore, we expect euro weakness. The Japanese yen could benefit if U.S. debt ceiling issues escalate, so the currency is likely to be very event driven.


Option strikes

GBP/USD reached year-highs of 1.26 in early May before slipping 2.5% over the next three weeks. GBP/USD is now re-testing these highs and hedge funds and asset managers are well positioned for a break to the upside, according to CME data on option strikes:

  • There is notable net demand for GBP/USD calls from 1.25 to 1.30 (Chart 3). Additionally, there is notable net demand for calls between 1.22 and 1.24.
  • On the downside, there is notable net demand for GBP/USD puts at 1.24 and 1.25 while puts also dominate from 1.18 and below.

What to watch: The Bank of England remains pivotal to the direction of the pound. As a result, May inflation data (21 June) will prove important as markets gauge whether inflation can hawkishly surprise once more. We think it could be comparatively tame as several strong one-off details drop from the print.

FX investor risk appetite

CME has a range of FX volatility data to help investors track the level of volatility. We can also use FX volatility data to determine investor risk appetite. We find the shape of the FX volatility curve useful in this regard. When shorter-dated FX implied volatility is higher than longer-dated volatility, this suggests investors are worried or in panic mode. In contrast, when shorter-dated FX volatility is lower than longer-dated volatility, this suggests investors expect calm markets. The latest data finds:

  • FX volatility curve inversion has continued to trend lower. Investors have found comfort in stable economic data alongside a Federal Reserve slowing its tightening cycle. This suggests investors are no longer in “fear” mode (Chart 4).
  • This aligns with CME's CVOL volatility indices, which have followed a similar dynamic, largely continuing their trend lower from their steep inversion in March.
  • Outside FX, equity volatility has been falling, while rates volatility remains historically elevated despite having pared lately.
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