Currently, there are three types of flows at play for GBP that could extend the current decline, says Morgan Stanley.
“First, since last Sunday evening, the shock factor that there could be a strong “Leave” campaign, increasing the probabilities of Brexit, pushed the initial leg down for GBPUSD. This type of ‘shock’ flow will likely extend a few more days as investors globally reconsider their Brexit-elated trading strategies. Our positioning tracker suggests that markets we real ready short GBP going into the weekend.
The second flow is based on the asset holders in the UK, never really having considered putting on tail risk hedge trades as an overlay in their portfolio, may use the currency as an easier (dueto its liquidity) and potentially cheaper way to hedge the risk. We are not just talking about the foreign investors here; GBP-based funds that are worried about potential equity market declines may also overlay with short GBPUSD positions.
Third, as GBPUSD declines rapidly and markets expect further declines, long-term foreign investors may start to hedge their currency risk, adding to further downward pressure. Remember that foreign investors had piled into gilts last year (GBP60bn in 2015) and FDI remained strong (GBP84bn in the year to September 2015). In particular, sovereign wealth funds were large investors into the UK’s real estate market over recent years too,” MS clarifies.
“We remain bearish on GBPUSD and see 1.3650 and 1.3500 as the next two areas of support,” MS advises.
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