Great Graphic: The Pound and Short Sterling

On July 4th, which some in the UK refer to as Thanksgiving, sterling rose to its highest level against the dollar since late 2008. Since then, sterling has gently slipped lower, with its $1.7070 print today, the lowest since the start of the month.

There are two forces that are weighing on it.  First is market positioning.  Sterling had rallied roughly five cents in five weeks against the dollar.  Speculators in the futures market have amassed a larger gross long speculative position in sterling than in the euro, Swiss franc and yen combined.  The gross long position peaked in mid-June near 100k contracts.   As  of last Tuesday July 8 the gross long position had slipped to 86.6k contracts, which is still larger than the combined gross long position of the euro, franc and yen. 

The second influence is the expectation of the timing of the first rate hike.   The Great Graphic here shows the price of the March 2015 short-sterling interest rate futures (white line).  The higher the price the lower the yield.   Sterling is the yellow line and to make it intuitively more understandable, we inversed the way sterling is usually quoted and instead quote the dollar against sterling.  As  the yellow line moves higher, sterling is getting weaker.  

What the chart shows is that as the market expectations for the first hike have been pullback back, sterling has lost its upside momentum.  The adjustment to speculative market positioning is not unrelated to this. 

The risk is that this week's data further pushes market expectations along the path it is presently moving.  A subdued CPI and labor earnings data will likely encourage investors to appreciate the lack of urgency to hike rates this year.  These, combined with more moderate real sector data, and the strength of sterling (on a trade weighted basis), which imparts a modest tightening bias, and macro-prudential measures to tighten some lending ratios mean that a rate hike is unlikely this year.  A convincing break of the $1.7070 area could signal a move toward $1.70 and maybe $1.6960.