May 24, 2024

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Traders bet against sterling in belief BoE will cut rates by summer

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Traders bet against sterling in belief BoE will cut rates by summer

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Investors have been building up bets against the pound, as conviction grows that the Bank of England will start cutting interest rates by the summer, ahead of its US counterpart.

Currency speculators’ wagers on a fall in sterling have reached a 16-month high, data from the US Commodity Futures Trading Commission shows. Meanwhile, asset managers have turned the most bearish on the UK currency since March last year, according to State Street, one of the world’s largest custodian banks.

The shift in positioning, driven by falling UK inflation and weak economic data, has helped push the pound down 1.5 per cent against the dollar this year. Investors now expect the BoE, which announces its latest rate decision on Thursday, to cut earlier and faster than the Federal Reserve.

“Everyone thought central banks would move together and now that assumption has been challenged,” said Michael Metcalfe, head of macro strategy at State Street. “Investors are going underweight sterling as the UK looks on track to ease ahead of the Fed.”

As recently as March, when data still showed UK inflation running ahead of the US, investors had clung on to bets that the Fed would cut rates ahead of the BoE.

But stronger than expected US economic data has left traders pricing in the probability of a Fed rate cut by late July at only one-third, compared with a near-50 per cent chance of a BoE cut by June. A drop in UK interest rates by August 1 is almost fully priced in by markets.

The change in expectations has come as US headline inflation rose to a higher than expected 3.5 per cent in March from 3.1 per cent in January. Over the same period, UK inflation dipped from 4 per cent to 3.2 per cent, twice undershooting expectations this year.

Traders are betting the BoE will deliver at least two quarter point rate cuts by the end of the year. That compares with just one or two cuts priced in for the Fed, even after weak US labour figures on Friday helped ease investors’ concerns about consumer price rises.

“Inflation hasn’t met the Fed’s target and doesn’t look like it will any time soon, so the Fed is on hold,” said Roger Hallam, global head of rates at Vanguard, adding that, in spite of last week’s jobs figures, economic data “has not given the Fed the confidence they need to start easing rates”.

In contrast, Imogen Bachra, head of non-dollar rates strategy at NatWest, which expects 1 percentage point of BoE cuts this year, said current market pricing for two BoE cuts this year still looks “far too low considering . . . the domestic data backdrop”.

Hedge funds and other leveraged funds upped their net short positions — bets on falling prices — on sterling to almost 29,000 contracts for the week ended Tuesday April 30, the highest level since January last year, according to CFTC data.

Line chart of Non-commercial leveraged funds' positioning (net contracts) showing Speculators have raised bets against sterling in recent weeks

State Street, which is custodian to $44tn of assets, said asset managers’ sterling holdings had dipped to the lowest level since March last year, reversing a buying trend that had picked up in the first quarter of this year when the Fed was still expected to deliver multiple rate cuts in 2024. 

Data from Citi shows that bearish bets on sterling picked up across its asset management clients over the past month, with net selling in 15 of the past 20 trading days.

Sam Hewson, the bank’s head of FX sales, said the net amount asset managers have sold to Citi was “roughly twice as large as the historical norm over any two-week period over the past 10 years”.

The bets against sterling have come as falling US bond prices have weighed on gilts. Yields, which move inversely to prices, on benchmark 10-year Treasuries and gilts have both risen by about 0.6 percentage points since the start of the year.

“You have had gilts trading like Treasuries for the last six weeks or so when they should be more like euro [European government] bonds,” said William Vaughan, associate portfolio manager at Brandywine Global, given that UK data has been more in line with the Eurozone than the US.

Analysts expect dovish guidance from the BoE on Thursday, despite widespread expectations that rates will be left on hold at 5.25 per cent. When the bank published inflation forecasts in February, it predicted inflation would come back to target in two and a half years, while investors were pricing in about five cuts for 2024. 

“The MPC [the BoE’s Monetary Policy Committee] could easily judge that inflation at the 2-3 year horizon will be below target,” said Tomasz Wieladek, chief European economist at T Rowe Price. “This would be a green light for a cut in June and would lead investors to price in more cuts.”