Goldman Says Bet on Higher Pound Despite Trade Becoming Crowded

© Bloomberg. British 10 and five pound banknotes sit in this arranged photograph in London, U.K., on Wednesday, Nov. 7, 2018. Even fund managers who were once shunning the pound are now betting on a rally as the U.K. inches toward a Brexit divorce deal. Photographer: Chris J. Ratcliffe/Bloomberg

(Bloomberg) — The pound rally has further to go as Brexit hedges are unwound, even as bets on the currency’s appreciation have become an increasingly crowded trade, according to Goldman Sachs Group Inc (NYSE:).

As the prospect grew of a longer delay to the U.K.’s exit date from the European Union, the pound jumped to the highest since July. An increasing number of foreign investors who bought hedges since the June 2016 Brexit vote need to reduce those positions and that will mean continued support for sterling, the firm’s market strategy chiefs told clients at a conference in Sydney on Wednesday.

A more than 2 percent appreciation in the pound over the past five days has sent the U.K. currency on a world beating rally as the risk of a no-deal outcome fades. Long positions in sterling is the trade now looking the most crowded, especially in the options markets, said Brian Friedman, Goldman’s global head of market strategies.

That isn’t dampening the firm’s appetite to wager the rally has legs. That’s in part due to the relative scarcity of sterling due to overseas merger activity since 2016 that sucked up pounds, said Bernhard Rzymelka, head of Europe rates market strategies for the firm. As companies wind back hedges placed during the past two years of Brexit uncertainty, that leaves room for the currency to rise, he said.

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Hedges Come Off

“When the hedges have to come off, the pounds are not there anymore because they’ve gone for good into corporate coffers, and so there is a good risk of an overshoot in the pound,’’ Rzymelka told the Goldman Sachs macro conference.

In bonds, investors are pricing a premium for interest-rate increases by the Bank of England and longer duration U.K. gilts have underperformed their European counterparts “quite significantly” in the latest rally, Rzymelka said. That leaves him favoring a pair trade: being long duration British debt and against that, be long the pound.

“If Brexit is really bad, then clearly growth in the U.K. is going to look worse than in Europe, and on the other hand every foreign central bank is now being priced to cut rates,” he said. “It doesn’t make any sense for the U.K. to price hikes.”

Friedman and Rzymelka are part of Goldman’s trading team, a separate division to its research department.

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