Pound Sterling's New Year 'Squeeze' Risks Making it Overbought
- Written by: Gary Howes
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The British Pound was fast to appreciate in the first half of January in a move some analysts say is partly a result of a positioning adjustment on global markets, and one analyst says the move might have now run its course.
Assessing the latest IMM data - the most comprehensive weekly snapshot on how currency market participants are positioned - revealed the Pound's rally in the first week of February resulted in a reduction in short positions.
A short position is where an investor buys option market bets to benefit should Pound Sterling decline in the future.
The market started 2022 with a consensus short on the Pound, but Francesco Pesole, FX Strategist a ING, says the most notable move in the market according to the latest IMM data was the drop in net shorts on the UK currency.
They contracted from 20% to 15% of open interest.
"This is a testament to how the pound’s oversold condition helped the currency find good support at the start of the year as rising bets on Bank of England tightening triggered a substantial short-squeeze in GBP," says Pesole.
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Valentin Marinov, Head of G10 FX Strategy at Crédit Agricole, says the recent readjustment in positioning now leaves Sterling overbought on one of their in-house FX models.
"The GBP enjoyed strong buying interest last week, driven by IMM flows. Our FX flow data points at banks, hedge funds, real money investors inflows and corporates outflows," says Marinov.
"The short-squeeze in the GBP has been too aggressive, however, and has pushed our GBP positioning indicator above its 2M moving average and into overbought territory," he cautions.
The Pound has risen against all G10 currencies thus far in 2022 with the GBP to EUR exchange rate recording a gain of 0.70% and the GBP to USD rate advancing 0.90%.
"GBP net short positions have dropped back sharply from their recent highs following the 15 bps December rate hike from the BoE," says Jane Foley, Senior FX Strategist at Rabobank.
Foley says money markets - which offer a gauge of how investors are anticipating Bank of England monetary policy to proceed going forward - is still positioned for "a fair amount of tightening".
But, "the fact that speculators are still net short of GBP still suggests that some types of investors remain sceptical of its outlook," says Foley.
The market is currently pricing in four rate hikes in the UK by the end of 2022 amidst expectations that rates will have to rise amidst soaring inflation and a an economy that is at, or very close to, full employment.
Should expectations for four rate hikes in 2022 fall back then the Pound could give up of its recent gains, or at least experience headwinds to further advances.
But, for now, dynamics are supportive of Sterling says ING's Pesole.
"While we think those expectations are overdone and should be unwound down the road, they are clearly offering a good deal of support to the pound at the moment," he says.
