The Federal Reserve and the Bank of England have been relying on forward guidance to help shape investors’ expectations for the policy outlook. Because the Federal Reserve is gradually slowing its asset purchase program, it has not had to rely as much on forward guidance as the Bank of England.
For its part, the Bank of England has been struggling to provide a consistent signal. The problem began with Carney’s Mansion House speech in the middle of June that warned investors against complacency. This hawkish signal sent the March 2015 short-sterling futures contract sharply lower. The implied yield jumped from 95 bp to 120 bp in sessions. Rates have been gradually trending lower since, albeit choppily, being whipsawed several times over the last two months by “temporally inconsistent” official comments.
With today’s quarterly inflation report, the damage inflicted by the Mansion House speech has been completely unwound.  The implied yield of the March 2015 short-sterling futures contract stands at 89 bp. It is slightly lower than when Carney warned against under-estimating. The OIS curve suggests expects for the first rate hike have been pushed from February 2015 to May. The risk is that the pendulum of market sentiment is swinging too far again.
Two events next week could prompt the pendulum to beginning correcting: the July CPI data and the minutes from this month’s MPC meeting. Unless prices fell in July, the year-over-year rate is likely to tick up from the 1.9% pace seen in June. More importantly, some economists have warned that there may have been a hawkish dissent at the MPC meeting. We have been a bit skeptical but recognized the risk. The recognition of this risk may also deter investors from pushing the March short-sterling futures contract much lower.
Sterling, which had been a market darling, precisely because of the anticipated trajectory of monetary policy, has fallen out of favor. It is slipping below $1.67 for the first time since mid-April. It is off a nickel from the high set a month ago. As of August 5, the gross speculative long position in the futures market stood near 66k contract, which is a third off the high seen in mid-June. The gross short positions have risen by 20% over the past two reporting period. The net position has been positive, even as speculators become increasingly short the euro, Swiss franc and yen.
