(Bloomberg) — Traders in the options market are preparing for the pound to tumble as much as 8% more as fiscal woes that prompted a painful selloff across UK markets last week weigh on the currency.
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There’s sizable demand for contracts that pay out below $1.20 — almost 2% lower than where the currency was trading on Friday — according to data from the Depository Trust & Clearing Corporation. Some traders are even betting on sterling falling below $1.12, the weakest level in more than two years.
Sterling proved the most fragile currency among developed-nation peers last week as concern about Donald Trump’s policies, sticky inflation and high levels of borrowing triggered a global retreat — with UK assets at the epicenter of the turmoil. Investors say the market is underestimating the need for rate cuts to spur the economy, another source of potential pressure for the pound.
“The path of least resistance is lower at this juncture,” said Jamie Niven, a fund manager at Candriam. “On one side, you have very limited pricing in of Bank of England cuts, while the fiscal concerns are also sterling negative.”
The pound slumped in tandem with other UK assets last week as 10-and 30-year gilt yields jumped a quarter percentage point and the FTSE 250 stock index notched its worst drop since mid-2023. That prompted comparisons with the market meltdown after Liz Truss’s disastrous mini-budget in 2022, although the severity of the moves was not matched.
Still, demand for pound options last week surpassed levels seen during that crisis — and even around the 2016 Brexit referendum.
According to Mimi Rushton, Barclays’ global head of currency distribution, there was a 300% increase in trade inquiries regarding sterling options, as hedge funds flocked to bet on further weakness. The unusually high volumes made some trading conditions “more challenging,” she said.
Contracts on the pound that pay out if it strengthens against the dollar were in favor at the start of the year. But the spike in bond yields seen last week has prompted the sharpest shift in sentiment in more than two years, the DTCC data show.
Demand for “longer-dated options remains quite elevated, suggesting that the market is not yet done with this theme,” said Tim Brooks, head of FX options trading at Optiver.
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The pound took another leg lower on Friday, after stronger-than-expected US jobs data raised expectations the Federal Reserve won’t be able to cut interest rates aggressively. The dollar climbed, leaving the pound down 0.8% against the US currency at $1.2207, its lowest since November 2023.
Strategists surveyed by Bloomberg on average see the pound rising to $1.26 by the end of the quarter, though the majority of these forecasts were made in December. Some banks altered their predictions last week in light of the violent currency-market swings.
In bond markets, the pace of yield increases slowed in the second half of the week after an 11 basis point spike in the 10-year yield on Wednesday. That left it at 4.84% on Friday, up 25 basis points in five days.
UK officials tried to reassure markets. Darren Jones, the Treasury’s chief secretary, said the gilt market was functioning in an “orderly way.” Big investors including Pacific Investment Management Co., Franklin Templeton and Fidelity International said they were sticking to their bullish bets on the nation’s debt.
Shreyas Gopal, a strategist at Deutsche Bank AG, is less optimistic about the UK currency. He recommends positioning for sterling to drop against a basket of other major currencies including the euro, dollar, yen and franc.
“There’s further to go in the recent pound weakness,” he said. It’s “time to turn short.”
–With assistance from Naomi Tajitsu.
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