Market Optimism on Pound Sterling Hits Fresh Multi-Year High

- CFTC data shows sentiment towards Sterling at most positive since summer of 2014

- Traders pile into the Pound betting it can continue going higher

- Citi forecast Pound higher against both Dollar and Euro in 6-12 months

The British Pound retains a broadly positive tone on Tuesday, April 10 with the currency at 1.4134 against the US dollar and 1.1476 against the Euro, placing the currency towards the top of its 2018 range against both currencies.

And if we look back over the last month, we note the Pound remains the best performing major currency as traders set aside Brexit-related fears and focus on fundamentals, such as the economy and Bank of England policy.

Data from the Commodity Futures Trading Commission - the largest report of its kind and the best insight into how market participants are betting - confirms traders continue adding exposure to the British Pound with the view that it will likely extend higher.

International Monetary Data (IMM) - a subset of data from the CFTC - gives insights into sentiment on a currency via positioning on the options market; options are financial products designed to deliver profit to their owner if the market moves their way over a set period of time.

The most recent data shows "longs" in Sterling at their highest level since July 2014; i.e. bets that the currency will rise over coming weeks are elevated.

There are now in fact more market participants who are holding bets that the Pound will rise than there are betting that the Pound will fall, a scenario that has been unthinkable for much of the post-Brexit referendum period.

In USD notional terms, the net long GBP position has climbed to a fresh multi-year high on the back of a $0.5bn week-on-week rise to $3.5bn.

"Details suggest a continued liquidation of gross shorts (at fresh multi-year lows) alongside a build in gross longs," says Shaun Osborne, an analyst with Scotiabank.

The previous week saw "longs" on the Pound stand at $3.0bn.

"The biggest individual position in G10 is long-GBP," says Stephen Gallo – European Head of FX Strategy at BMO Capital Markets, "based on a percentage-of-max metric, IMM leveraged funds’ biggest position is long-GBP at 96%. No other scaled G10 position comes close to long-GBP."

Long-NZD is the second-largest position in FX at 68% and it’s tied with short-USD, which is also at 68%.

In USD notional terms, Gallo notes long-EUR was the biggest currency side held by IMM leveraged funds with a notional value equivalent to USD10.5bln. However, that position is only 53% of its 3Y maximum, so it’s not particularly big from that perspective.

The shift in sentiment in favour of Sterling comes as traders believe the ongoing recovery in the currency has further to run. Brexit-related fears are less of a concern now that a provisional transitional Brexit deal between the UK and EU has been reached, allowing traders to focus on fundamentals, such as the economy.

Make no mistake, concerns about Brexit still exist, but certainly the worst-case scenario chaotic Brexit appears to have been scratched out of the equation.

And while there is the case to be made that the UK economy has endured a soft start to the year, look at the April PMIs which disappointed, there remains a convincing argument that the Pound is still notably undervalued when contrasted to the direction of travel in the economy. The economy is forecast to grow between 1.4% and 2.0% in 2018 and 2019, depending on which economist or institution you ask.

"GBP remains an extremely cheap currency according to its real effective exchange rate. Furthermore, capital flows in the form of net FDI and a more hawkish BoE have both been supportive of the currency," says a note from Citi, the world's largest dealer of foreign exchange.

Citi add that regarding Brexit, "the UK and EU agreed to have a transition period, triggering hope that the probability of a hard Brexit may reduce, which may underpin GBP."

A recent poll of economists from Reuters confirms an ongoing trend amongst economists to raise forecasts for the Pound. According to the latest poll on Sterling projections,  expectations for the currency are at their highest since the June 2016 vote to leave the European Union amidst broadening agreement that the UK currency can continue to climb higher.

Citi are forecasting the Pound-to-Dollar exchange rate to hit 1.4345 in the six- to twelve-month timeframe.

The Pound-to-Euro exchange rate is meanwhile forecast at 1.18 for the same timeframe.

However, it must be noted that positioning data from the CFTC often serves as an useful contrarian indicator; when positioning is elevated in a certain direction it could mean that the currency is at risk of moving in the opposite direction.

Why? Think of a market where all participants are betting in the same direction, without new entrants to the market the move fades, this explains why some currencies simply run out of steam despite an apparently supportive fundamental environment. And, any countermove could be sizeable as traders book profit or are forced out of the market.

So while positive on one hand, this data for Sterling could herald a sharp reversal.

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