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  • Leveraged funds have bearishly revised pound net positioning. Meanwhile, pound net shorts remain a stalwart of asset manager portfolios.
  • We think net positioning can trend even more bearish, with the pound unlikely to outperform the U.S. dollar over the medium term. Our analysis of CME Group data on option strikes suggests markets are weighted to downside over upside, too.
  • The FX volatility curve using CME Group options data suggests investors are in “calm” mode.

2023 appears to be a story of two halves for the pound. It traded as high as 1.31 in the summer, an 11% rally from March lows. It then fell 8% in under three months as UK pessimism replaced overoptimism. However, it is now trading 3.2% higher than its October lows as markets find a reason to believe the Bank of England’s higher-for-longer mantra, while the dollar has slid following the October CPI release.

Market participants are doubting this rally. Leveraged funds have closed 24.0k long pound positions over the past month but only closed 3.1k short positions (Chart 1). No other currency has seen a larger revision over the period, though the second- and third-largest revisions are also bearish (NZD: -5.9k; JPY: -4.2k).

Yet only leveraged funds have delivered bearish changes; asset managers were already bearish (current: -63.7k; Chart 2). They have not budged, either – pound positioning has seen the smallest position revision over the past month. This leaves the pound as the currency they are second most short, trailing only the Australian dollar (-67.8k).

Macro Hive take: We see little reason to chase pound strength against the U.S. dollar. While the November BoE meeting, recent UK wage data and soft U.S. CPI outturn have bolstered the pound, reality is yet to hit in the UK. The labour market is weaker than the BoE is portraying, and the December ONS data update will likely reveal this weakness. Meanwhile, inflation could prove less stubborn than forecasts suggest, given higher wage forecasts and a stronger labour market forecast are likely supporting it.

Option strikes

Pound strength is yet to convince investors. According to CME Group data on option strikes:

  • There is notable net demand for GBP/USD puts from 1.22 with the strongest concentration around 1.16 (Chart 3). Put demand is also notable at 1.21 and 1.20, too.
  • Bullish demand is comparatively more contained. Most call options sit between 1.24 and 1.25, though there is a spike at 1.26, too.

What to watch: further pound upside relies on optimistic BoE forecasts. December is an important month there. The ONS’ planned improvements and reintroduction of the labour force survey on 12 December will likely prove a dovish outturn for the BoE, which meets on 14 December. Consequent dovish revision of market pricing for the BoE would hurt the pound.

FX investor risk appetite

CME Group 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:

  • The FX volatility curve continues to flatten towards summer lows, having been steep only momentarily earlier in the summer (Chart 4). This suggests investors are becoming surer that a soft landing is possible and are calmer.
  • The move aligns with CME Group CVOL volatility indices, which have followed a similar dynamic, trading near year lows.
  • Outside FX, equity volatility remains historically low, while rates volatility has resurged.

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