Pound, Euro at Risk of Further Downside as Hangover from Recent Stock Market Volatility Lingers

The Chase Tower, New York © Kristen Cavanaugh, Flickr

Research suggests the impact on currencies from spikes in volatility tend to last for a matter of weeks suggesting potential for steady selling pressures on the Pound and Euro to be maintained.

The most recent data into how currency traders are positioned showed bets for a stronger Sterling and Euro slipped by around 10% as volatilty on global stock markets spiked.

And, research suggests the impact on currencies from spikes in volatility tend to last for a matter of weeks suggesting potential for steady selling pressures to be maintained.

Traders cut back their bets for a rise in the Pound and Euro earlier this February as stock market volatility rocketed with institutional money managers cutting their 'long' exposure on the Pound by around 12% during the week ending Tuesday 13, February, leaving them with a reduced cash pile of around £1.7 billion on the table.

Leveraged funds, another category of institutional speculator, also cut back their bets by around 10% to £4.3 billion during the same week, both according to Chicago Futures Trading Commission (CFTC) data.

It’s no coincidence the Pound struggled against the US Dollar during that week and that it remained under pressure against the Euro.

Sterling ended the period 100 points lower at 1.3850 against the greenback and was unchanged against the Euro after having failed to sustain a march higher against the common currency.

Strategists at J.P. Morgan warn that a reversal of the market’s 'long' bets could well undermine the Pound and Euro as the end of February approaches, given earlier volatility in financial markets.

“In historical instances when VIX surged above 35, in all instances [institutional money manager] positions were cut both on the long and short side (vs USD), on average a third over two weeks, and cumulatively by a half in the month following the spike,” wrote Daniel Hui, a strategist at J.P. Morgan, in a recent note.

Hui’s warning came after fears over a sudden increase of global inflation and interest rates sent the VIX index, a “fear gauge” that measures volatility on the S&P 500, surging by more than 150% on February 06. It’s largest single day rise on record.

Global stock markets fell precipitously during the subsequent week and, it turns out, institutional money managers began cutting back their exposure to currencies other than the US Dollar.

It’s probably no coincidence either that during the week to Tuesday, 13, February, the Dollar index saw its first positive seven day performance since late November.

“Currently positioning shows the biggest longs in EUR and GBP...The biggest shorts are in USD, JPY, and CHF, on average,” Hui wrote.

Tellingly, bets in favour of the Pound were not the only ones to get clipped in the week to February 13, as speculators also began to close out their Euro long positions at a decent rate too.

Asset managers dumped €1.3 billion during the week to February 13 while leveraged funds took more than €2 billion off the table, making for a near 10% reduction and leaving both categories with a collective €42 billion long.

The Euro closed more than 100 points lower against the US Dollar, at around 1.2280, on February 12.

While both Sterling and the Euro have seen net long positions slip by around 10% over the week to February 13, the CFTC data accounts only for the first seven days after the initial “shock to the VIX” index.

If Hui’s analysis is correct and volatility makes a return over coming weeks, both the Euro and Sterling could struggle to keep their heads above water as investors and traders continue to cut back their exposure.

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