Synopsis:

SocGen anticipates that traders may transition from short EUR/USD to short GBP/USD positions on any GBP recovery, given persistent challenges for sterling and the dominance of US economic exceptionalism.

Key Points:

1. Sterling Vulnerability:

   • GBP typically experiences significant moves rather than stagnation, and the current environment hints at further downside risks.
   • Unlike the "Truss Crisis" in 2022, this episode reflects deteriorating growth due to fiscal measures and worsening public finances.

2. Comparison to 2022 Crisis:

   • The extent of recent GBP/USD declines and gilt yield spikes is smaller than the 2022 crisis, but the current setup highlights limited investor appetite for gilts.
   • Thin post-New Year markets exacerbate volatility, with fewer "buy-the-dip" opportunities in gilts compared to pre-Brexit conditions.

3. Shift to GBP/USD Shorts:

   • Traders may move away from short EUR/USD and focus on GBP/USD shorts, particularly given the lack of drivers for GBP outperformance against the EUR.
   • GBP/USD is likely to remain under pressure due to US economic strength and a widening US-Europe/Asia rate differential.

Conclusion:

SocGen expects limited upside for GBP and highlights the likelihood of traders favoring GBP/USD shorts on any sterling bounce, reflecting structural and fiscal challenges alongside US economic dominance.