Ahead of the budget proposal, GBP short positions surge, Morgan Stanley bearish forecast at 1.30 by year-end

According to reports from Zhihu Finance APP, traders are increasing their short bets on the British pound ahead of the new UK government's first budget, set to be released in a month. Industry data shows that, this month, two-thirds of the market's trading volume in GBP options are bets that the pound will decline against the US dollar in the week following the October 28 budget. According to data from the Depository Trust & Clearing Corporation (DTCC), put options against the euro account for as much as three-quarters of volume. Major banks such as Morgan Stanley have also lowered their forecasts for the pound.

Investors are concerned about the UK's fiscal situation and how the new Chancellor of the Exchequer, John Healey, will balance the books. One-month contracts cover the budget announcement, and the cost of hedging this event is rising, with expected GBP volatility reaching its highest since July.

Morgan Stanley lowers pound forecast

David Adams, head of FX strategy at Morgan Stanley, commented, "We see asymmetric risk, and investors may price in more negative risk premium for GBP ahead of the October budget." The US bank has sharply lowered its pound forecast, expecting it to fall to $1.30 by year-end and $1.27 by mid-2027.

The pound has been under pressure due to renewed US dollar demand triggered by US-Iran tensions and Fed rate hikes, losing over 2% this month and marking its worst performance in almost a year. The risk reversal index, which serves as a barometer of positioning, also reflects increased short bets on the pound.

However, it is worth noting that there remains significant divergence in long-term market views on the pound. Morgan Stanley previously forecast that by the end of 2025 the pound could reach a range of 1.43 to 1.51 in 2026, possibly hitting its highest level since the Brexit referendum, based on the logic that a Fed rate cut cycle would erode the dollar's interest-rate advantage.

Goldman Sachs maintains a neutral stance, believing the pound's upward momentum may stall around 1.35 to 1.36, and anticipates the Bank of England will cut rates three times to 3% by 2026. Wells Fargo is more bearish, predicting a decline to around 1.31. Current market pricing has already shifted noticeably towards the bearish end, and the divergence itself sets an important background for trading.

UK government bonds see sharp volatility

UK bonds have experienced sharp volatility this month due to concerns about fiscal conditions. Middle East tensions have pushed up UK borrowing costs, and Healey will strive to repair public finances. On Monday, UK government bonds fell while the pound held around $1.3255.

Roberto Cobo Garcia, Head of G-10 FX Strategy at Banco Bilbao Vizcaya Argentaria, said that a credible budget that preserves fiscal space may help curb volatility in the pound and UK government bonds, but any fiscal consolidation may come at the expense of growth. "We think there is limited room for a positive surprise from the budget," said Cobo Garcia.

Some bond investors believe that the surge in yields caused by the war has made rebuilding Healey’s fiscal buffer to previous levels “unrealistic,” while others think that a buffer below £20 billion would pose problems and the government should stick to the OBR’s forecast levels.

Healey previously stated he would use a “buffer to address uncertainty” in meeting fiscal rules, without specifying a target. The government is considering higher taxes on wealth to fund spending, including a bank levy, increasing capital gains tax, and lowering the “mansion tax” threshold from £2 million to £1.5 million.