Analysis: Investors are suffering from long-term pain in debt-ridden UK markets

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By Naomi Rovnik, Neal McKenzie and Yoruk Bahceli

LONDON (Reuters) – Investors who had been enjoying a short-lived recovery in long-suffering U.K. markets are facing losses as the pound, government bonds and stocks feed off each other, putting Britain at risk of a headwind. Hedge fund attacks.

Britain’s highly indebted and low-growth economy is now seen as vulnerable to capital flight after years of post-Brexit gloom as global borrowing costs rise in a trend led by the US Treasury market.

Traders now expect months of volatility in the pound, which is expected to continue in 2018. 2024 The Labor Party’s July election win as the top performing currency against the dollar signals the end of years of political instability.

That has dampened interest in UK stocks and now fresh currency risks and uncertainty over Bank of England interest rates as the country’s debt burden mounts, threatening already subdued economic growth.

There are signs that the pain will be permanent. Options trading data and information from hedge fund industry insiders and securities desks indicate that estimates are stacked in bets on the pound and UK gilt.

Brandywine Global Fixed Income Portfolio Manager Jack McIntyre said of the UK disaster that investors are worried by memories of the 2022 Giles and spectacular crisis sparked by former Prime Minister Liz Truss Mini, “I don’t think it’s going to end any time soon” – Budget.

The US-based asset manager said it had started exposure to UK gilts on the basis that these assets would benefit from falls in value, but hedged this with contracts that would have been profitable if sterling, which is now down 2.5% against the dollar this month.

Buyers’ strike

Just months ago, British markets were shining a sign of calm amid French political turmoil and looked poised to recover from prolonged government turmoil, currency volatility and the alienation of overseas investors.

In the year Mario Monti, the economist who led Italy out of bankruptcy in 2011, said: “January’s market movements focused many minds around the world on Britain, its economy and its financial situation.”

Long-term UK borrowing costs hit a 27-year high and the domestically-focused FTSE 250 share index is down 6% since August. A measure of buying resistance to sterling volatility is near its highest since March 2023.

“The UK is particularly vulnerable to a post-Brexit buyer’s strike because it is a smaller hub for many global investors and has a less clear growth track record,” Krishna Guha, vice chairman of US investment bank Evercore ISI, said in an email.

Bank of America warned this week that a “significant escalation could lead to volatile movements in gilts (and) sterling, which in turn would undermine growth sentiment and negatively impact equities.”

‘The weakest link’

Rising debt costs have hampered Finance Minister Rachel Reeves’ plans to stimulate growth through public investment, while sterling’s fall has left the BOE on edge over whether to cut inflation further.

“As a low-growth economy with relatively high interest rates, the UK is very much riding with the wind,” said Shahab Jalinos, head of G10 FX strategy at UBS Investment Bank.

“Business is like the weak link in a world of rising interest rates.”

Opinion polls show Brexit campaigner Nigel Farage’s Reform Party is rising in popularity, while Labor leader Keir Starmer’s ratings have fallen.

Tom Lemaigre, European equities manager at Janus Henderson, said: “The political uncertainty that we thought we had ended when the July election happened is back.”

He awaited renewed sterling volatility, which could risk foreign investors trading into UK equities.

HEDGE FUNDS CIRCLE

“Hedge funds are buying and selling sterling right now,” said Liam O’Donnell, portfolio manager at Artemis Fund Management.

“It’s active money, active short selling is coming into the market,” he added, referring to the practice of borrowing securities in hopes of selling them, then buying them back cheaply.

Brokers are charging up to 30 basis points (0.3%) to lend gilts for appraisals, nearly double the 10-year average, reflecting strong demand from short sellers, according to S&P Global Market Intelligence data.

Trend-following hedge funds, called CTAs, are mostly betting against the pound and UK gilt, JPMorgan said in a client note.

The UK’s slowing growth attracted a “subset” of hedge funds to short sell sterling, said Tom Finnerty, senior research analyst at Franklin Templeton Investment Solutions.

Still, some see the wave of sales as an opportunity.

“I think the concern is worse now,” said Mario Unali, head of investment advisory at hedge fund investor Kairos.

He was looking at UK exposure in the next few months, he said.

(Reporting by Naomi Rovnik, Neal McKenzie and Yoruk Bahceli in London. Editing by Elisa Martinuzzi, Amanda Cooper and Hugh Lawson)