LIVE MARKETS-While the dollar smiles, is the pound scowling? MS thinks so

Welcome to the home for real-time coverage of markets brought to you by Reuters reporters. You can share your thoughts with us at markets.research@thomsonreuters.com.

WHILE THE DOLLAR SMILES, IS THE POUND SCOWLING? MS THINKS SO

"The dollar smile" theory is a nod to the greenback's ironic tendency to rise both when the U.S. economy is weak and strong.

Markets like vivid imagery to distil complex topics, and Morgan Stanley strategists have gone a step further, coining "the Sterling scowl". The idea is that the pound trades in a frown-like pattern to UK rates.

On the right-hand side of the "scowl", is where rates rise too much, either driving or driven by fiscal concerns, and hurt the pound. On the left-hand side, where rates fall too much, any uplift to the pound from carry trades starts to fade, Morgan Stanley say.

The "sweet spot" for the pound is right in the middle, where rates keep carry attractive, while volatility remains low. Right now, that carry-to-vol ratio is in that spot, but the risk is for it to shift to the right-hand side of the "scowl", MS says.

"This chimes with a bullish skew on cable and GBP crosses but keeps us from outright GBP longs."

Carry trades, where investors borrow in a low-yielding currency like the yen and invest in assets whose currencies bear higher interest rates, like the pound, are a popular way to play rate differentials.

The pound's 2025 outperformance comes despite bearishness over the economic outlook, in part due to its attractive carry relative to volatility.

But this outperformance is on thin ice. The pound's correlation with local rates can flip suddenly and often unexpectedly, according to MS. Normally, when rates rise, a currency rises. This week's rout shows that this correlation can quickly vanish, pushing the pound lower even though bond yields are rising.

For now, Morgan Stanley say they're bullish on cable and the crosses but with "a meaningful degree of cautiousness."

"We will be watching FX vol, GBP's relative carry versus its peers, and the outlook for both UK fiscal and growth closely to gauge where we stand on the Scowl."

(Lucy Raitano)

*****

EARLIER LIVE MARKETS POSTS

TARIFFS NOT QUITE EVERYWHERE ALL AT ONCE CLICK HERE

EUROPE BEFORE THE BELL: TARIFF WORRIES ARE BACK CLICK HERE

MORNING BID EUROPE-MARKET FOCUS SHIFTS TO TRUMP TARIFF COUNTDOWN CLICK HERE