Authors: Naomi Rovnik, Nell MacKenzie and Yoruk Bachelli
LONDON (Reuters) - Investors who had enjoyed a brief rebound in long-suffering British markets are now looking ahead to a period of losses as moves in sterling, government bonds and stocks feed into each other and Britain faces a wave of risks. Hedge fund attacks.
Britain's high-debt, low-growth economy, which just months ago appeared to be emerging from a multi-year post-Brexit slump, is now seen as vulnerable to capital flight as global borrowing costs rise, led by U.S. Treasury markets.
Traders now expect months of volatility in sterling, which ends 2024 as the best-performing major against the dollar on optimism that Labor's landslide victory in the July election would mark the end of years of political instability. currency.
This is creating a negative feedback loop, undermining interest in UK stocks, which now face new currency risks, and raising doubts about a Bank of England rate cut, posing a threat to already stagnant economic growth as the country's debt burden grows. .
There are signs that the pain will continue. Options trading data and evidence from hedge fund insiders and securities trading desks suggest speculators have bet heavily on sterling and gilts.
"I don't think this is going to end anytime soon," Jack McIntyre, fixed income portfolio manager at Brandywine Global, said of the UK stock market rout, noting that former Prime Minister Liz Truss The memory of the 2022 gilt and sterling crises triggered by mini-currencies still has investors spooked. -Budget.
The US-based asset manager said he held gilts because they would benefit from interest rate cuts, but he hedged with contracts that would keep falling if sterling, which has fallen 2.5% against the dollar this month, continued to fall. Profit.
Buyers strike
Just a few months ago, British markets shone as a beacon of stability amid the political chaos in France, seemingly poised to recover from a prolonged period of government turmoil, currency volatility and the shunning of overseas investors.
Mario Monti, an economist appointed in 2011 to lead Italy's response to the financial crisis, said January's market moves "refocused the attention of many people around the world on the UK, its economy and its financial situation" .
Britain's long-term borrowing costs have hit a 27-year high, while the domestically focused FTSE 250 share index has fallen nearly 6% since August. An indicator of buy protection against sterling volatility is near its highest level since March 2023.
Krishna Guha, vice chairman of U.S. investment bank Evercore ISI, said in an email: "The UK is more vulnerable to a buyer's strike after Brexit because for many global investors, Britain's Core holdings are lower and the growth story is less clear. ”
Bank of America warned this week that "a significant deterioration in the situation could lead to disorderly moves in gilts (and) sterling, which would undermine growth confidence and have a negative impact on equity markets."
"The weakest link"
Soaring debt costs have hampered Finance Minister Rachel Reeves's plans to revive growth through public investment, while sterling's fall has left the Bank of England in a bind to prevent rate cuts from exacerbating currency weakness, pushing up import cost inflation. .
"As a low-growth economy with relatively high interest rates, the UK is facing headwinds," said Shahab Jalinoos, head of G10 foreign exchange strategy at UBS Investment Bank.
"In a world of rising interest rates, it's trading like the weakest link."
Political sentiment is also running high again, with polls showing support for Brexit campaigner Nigel Farage's Reform Party surging while Labor leader Keir Starmer's ratings plummet.
"When the (July) election happened, the political instability that we thought was over came back," said Tom Lemaigre, European equities manager at Janus Henderson.
He expects sterling to become volatile again, which could deter foreign investment in British equities, which face currency risks.
Hedge Fund Circle
"Hedge funds are now selling sterling and gilts," said Liam O'Donnell, portfolio manager at Artemis Fund Management.
“This is active money and active short selling coming into the market,” he added, referring to the practice of borrowing securities with the intention of selling them and then buying them back at a cheaper price.
Data from S&P Global Market Intelligence showed that brokers were charging as much as 30 basis points (0.3%) to lend gilts to speculators, nearly double the 10-year average, reflecting increased demand from short sellers.
Trend-following hedge funds known as CTAs were mostly short sterling and British gilts, JPMorgan said in a client note.
Tom Finnerty, senior research analyst at Franklin Templeton Investment Solutions, said lagging UK economic growth had attracted "a subset" of hedge funds shorting the pound.
Still, some see the sell-off wave as an opportunity.
"I think the pessimism is now at its extreme," said Mario Unali, head of investment advisory at hedge fund investment firm Kairos.
He said he was considering venturing into the UK market in the coming months.
(Reporting by Naomi Rovnick, Nell Mackenzie and Yoruk Bahceli in London. Editing by Elisa Martinuzzi, Amanda Cooper and Hugh Lawson)