British political "earthquake" affects the forex market! Hedge funds go crazy shorting the pound, by-election could be a matter of life and death.

As the power struggle within the UK's ruling Labour Party intensifies, hedge funds and asset management firms flooded into the pound sterling put options market last week, betting on further depreciation of the pound. The core factor triggering this wave of short selling is Manchester Mayor Andy Burnham's successive clearing of obstacles on his return to parliament, significantly increasing the possibility of challenging current Prime Minister Keir Starmer's leadership position, leading to deep concerns in the market about loosening fiscal discipline and political uncertainty in the UK. Burnham paves the way to return to parliament, Prime Minister's position in jeopardy On May 14th local time, Labour MP Josh Simmons announced his resignation from the Mecklenfeld constituency seat, explicitly clearing the way for Burnham to return to the House of Commons. Simmons stated on social media that the government failed to bring about the necessary reforms to the constituency, and therefore decided to "make room for a leader with courage, vitality, and great courage." The next day, the Labour National Executive Committee approved Burnham's candidacy for the Mecklenfeld by-election. This marks a crucial step for Burnham on the path to party leader and even Prime Minister. According to Labour Party rules, only current members of the House of Commons are eligible to participate in the party leader election, and obtaining a parliamentary seat is a prerequisite for Burnham to challenge Starmer. British media revealed that hundreds of Labour MPs have publicly called for Starmer's resignation, and Health Minister Wes Streeting announced his withdrawal from the cabinet citing a lack of confidence in the Prime Minister, deepening further internal divisions within the ruling party. Polls show that Burnham leads the Labour leadership successor popularity list with 42% support and a net approval rating of 72%. Mohit Kumar, economist at Jefferies, said: "The market is concerned that Burnham may lean further left, thereby further increasing the deficit. Our base scenario is that Starmer will orderly step down, and Burnham is likely to become the next Prime Minister." Mitsubishi UFJ Financial Group pointed out: "Although Burnham is not a sure bet, he still has a strong chance. Considering the strong support for the 'Reform Party' shown in local elections last week, this by-election will become particularly significant." The Mecklenfeld by-election is expected to be held as early as June 18, and the results may become a key milestone in determining Starmer's political fate. Options market sends a strong warning signal Political uncertainty quickly spread to the foreign exchange market. According to data from the Depository Trust & Clearing Corporation (DTCC), the trading volume of pound sterling put options against the US dollar worth no less than 100 million was more than six times that of call options during May 14th-15th. At the same time, data from the central limit order book of the Chicago Mercantile Exchange Group showed that the trading volume of pound sterling put options against the US dollar surged to the highest level since April 8, 2024, last Thursday. Foreign exchange options' implied volatility also sharply increased. The one-month implied volatility of pound sterling against the US dollar jumped from a historical low of 6.3 to 7.5, and the risk-reversal premium of pound put options relative to call options reached its highest level since April, reflecting a sudden increase in the market's pricing of downside risk for the pound. Julian Weiss, G-10 Foreign Exchange Options Trading Manager at Bank of America in London, said: "As political noise increases, we see demand for pound put options increasing in both short-term and long-term funds." Market sentiment reverses in the spot market, multiple bearish factors weigh on the pound Bearish sentiment is not only reflected in the options market, but also in the spot market positions. Rob Turner, Head of Electronic FX Trading at RBC Capital Markets in London, pointed out that investors still held a small net long position in pound sterling against the US dollar at the beginning of last week, but by the end of last Thursday's close, the position had turned into a small net short position. Traders are increasingly focusing on options contracts covering the by-election window on June 18. The premium of options to hedge downside risks for the pound in the next two months relative to protective contracts rose its largest single-day increase since September 2nd on last Thursday. The pressure on the pound also comes from other factors. In addition to escalating domestic political turmoil in the UK and market concerns that Burnham's coming to power might push for increased government borrowing and public spending, weakening fiscal discipline, the strengthening of the US dollar also exerts external pressure. The US April CPI rose by 3.8% yoy, exceeding expectations, coupled with the risk aversion demand triggered by the Middle East tensions, the US dollar index rose by 1.3% on a weekly basis to 99.10, marking its largest weekly gain in two months, the 10-year US Treasury yield rose to a nearly one-year high above 4.5%, and the market's expectation of the probability of the Fed raising interest rates at least once by the end of 2026 has risen to about 50%. At the same time, the stalled US-Iran talks have pushed up oil prices significantly, and the rise in energy costs further supports the demand for the US dollar. Antony Foster, G-10 Spot FX Trading Manager at Nomura International in London, said: "We are seeing selling pressure on pound sterling against the US dollar in the market, reflecting both UK political concerns and additional pressure from rising oil prices and lack of progress in Iran negotiations." However, he also pointed out that customers in the spot market are currently "unwilling to chase lower" pound sterling against the euro.