LONDON (Reuters) - The Bank of England just gave hedge funds a bloody nose.
Warnings from BoE officials - as sudden as they were stark - that interest rates could soon go up have sparked the biggest ever reversal of hedge fund bets that sterling will weaken.
In the week to Tuesday, Sept. 19, hedge funds slashed their net short positions on the Chicago futures markets by 35,924 contracts to just 10,161, the smallest bet against the pound in nearly two years.
That change from the previous week was the largest positioning shift in favour of the pound on record, and the fourth largest weekly swing in either direction since Commodity & Futures Trading Commission data tracking hedge fund and other speculative bets in currency futures began in 1995.
It has been another bruising year for macro hedge funds, which take directional bets on interest rates and currencies and were up only 2.7 percent January-August, according to Eurekahedge’s Macro Hedge Fund Index.
On Sept. 14 the Bank of England said it was likely to raise rates in the coming months if the economy and price pressures kept growing. It was the clearest signal to date that Britain’s first rate hike in a decade is approaching.
Trade-weighted sterling had its biggest weekly rise since 2009 - and fourth largest in 40 years - and short-dated gilt yields chalked up the biggest weekly rise in two and a half years as markets adjusted to the prospect of higher rates.
Several big banks revised up their sterling forecasts, the steady slide toward parity with the euro was reversed, and money markets now reckon a rate hike this year is more likely than not.
That’s not how hedge funds had been positioned. Since the Scottish independence referendum almost exactly three years ago, they have held a virtually unbroken short position on the British pound, effectively betting that it will fall.
The size of that bet has varied, growing noticeably after the Brexit referendum in June last year and reaching a record 107,844 contracts in March this year. The next set of CFTC data could show that hedge funds are now net long sterling.
But that doesn’t mean sterling’s rally will continue. If anything, the market’s most neutral positioning since November 2015 has paved the way for the speculative trading community to rebuild its short positions.
The pound has come a long way in a short time, so is vulnerable to profit taking. Especially as the quarter-end is fast approaching, and given largely negative news flow for the pound.
Brexit negotiations between the government and EU, as well as the economic outlook, remain challenging at best. Both were factors behind Moody’s decision last week to downgrade Britain’s sovereign credit rating.
The opinions expressed here are those of the author, a columnist for Reuters
Reporting by Jamie McGeever; editing by John Stonestreet