Currency speculators increased their bullish bets on sterling to its highest level in nine years, despite recent indications that sterling’s strong rise this year may be flagging.
The increasing consensus among hedge funds and speculative traders comes after sterling rallied strongly in this year. This was largely due to the Bank of England raising borrowing rates to curb inflation. On Monday, the pound was trading at $1.2698. This is a 5% increase against the dollar compared to the beginning of January.
The markets believe that the BoE must go further as the UK’s rising prices are proving to be particularly stubborn compared to other economies. This is just at the time when other central banks are approaching the end of tightening cycles. This expectation drove the yield on two-year UK Government Bonds, which is sensitive to interest rates, to a 15 year high of 5,40% on Monday.
According to the US Commodity Futures Trading Commission, leveraged non-commercial funds increased their net long position on sterling from almost 48,000 contracts to 52,000 contracts in the week ending Tuesday June 27. This is the highest level seen since July 2014. These figures are closely monitored as a gauge of currency speculation on futures markets.
Simon Harvey, Monex Europe’s head of FX Analysis said: “The position shows that speculators are more bullish about sterling.” It’s a wager that the Bank of England is going to be pushed by its hair into raising rates. The recent volatility of the UK currency has led to a rise in betting on sterling. The pound is down by almost 1% since the BoE raised interest rates unexpectedly to 5% on June 21. This has upset the usual correlation between higher rates, and stronger currencies.
Investors believe that recent weakness is a market signaling aggressive rate increases will kill growth, cause a recession and deter foreign capital.
Paul Robson is a currency analyst at NatWest. He said that currencies where central banks keep rates high due to strong growth, and not because of high inflation, will likely be favoured. The fact that the BoE tightens because of persistently high inflation is a negative factor for the pound.
Analysts argue that an overcrowded bet in favor of a stronger pound can lead to a pullback. This is because many investors may abandon their positions if market conditions turn against them.
Francesco Pesole is a currency analyst at ING. He said, “In theory, we should see a larger drop because more positions could be reduced.” “We believe sterling is vulnerable.”
Others argue that the higher UK interest rate should continue to support currency. “We still encounter a lot of scepticism that sterling can rally with [bond yields] back where they were last autumn,” said Kamakshya Trivedi, head of global foreign exchange, interest rates and emerging markets strategy research at Goldman Sachs, referring to the period after September’s mini-Budget when the pound tumbled despite rocketing interest rate expectations. “But things could not be more different now.”
Trivedi stated that real incomes have improved due to the decline in energy prices and the strong labour market. The BoE is no longer a “reluctant increaser” because of this. He said: “We are confident that the pound will strengthen as real interest rates rise.”
The markets have re-evaluated the outlook for UK rates this year. The swaps market is pricing multiple rate increases to a maximum of 6.25 percent early next year.
The markets are pricing in two 0.25 percent rate increases from the European Central Bank in this year and another by the Fed for July.