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Sterling: the futures converging to cash

Copyright © 2012 Seven Days Ahead

Republish: EasyPublish™ Published: 11Feb2010 Word count: 450 Viewed: 379 time(s) Get Free Content For Your Site

The Short Sterling futures market has been too bearish, expecting the Bank of England to begin raising interest rates both sooner and further than now appears the case.

The Macro Trader's view:

The Short Sterling futures market has been too bearish, expecting the Bank of England to begin raising interest rates both sooner and further than now appears the case. Despite: - record low interest rates, - an unprecedented quantum easing program by the Bank of England, and - a sizeable fiscal stimulus and debt deterioration, that is unparalleled in peace time.

The economy only just managing to limp out of recession in the 4th Quarter. And the economy still looks in need of assistance. The Bank has now stopped its QE program as CPI inflation and RPI inflation are both in positive territory, indeed, CPI is well above target. Why then isn't the Bank's MPC raising rates to control inflation? That is because economic activity remains weak. Also, a large output gap has opened up in the economy because of the depth of the recession and monetary policy makers expect this to bear down on inflation and bring it back below target.

In fact, the Bank of England had forecast this current 'temporary' spike which they attributed to one-off factors such as last year's VAT cut which was restored earlier this year.

There another reason why they are likely to leave interest rates at current low levels for much of, if not all of this year. For without low rates the economy will not survive the impending fiscal consolidation so necessary to reduce the budget deficit and the level of debt compared to GDP. Whomever is returned to office will have to take concrete steps to cut the deficit, Labour probably through higher taxes, the Conservatives favour spending cuts.

If the deficits are not reduced, rating agencies have already warned the UK's AAA sovereign rating could be at risk without serious fiscal consolidation, and that would be bad news for funding the deficit.

Official interest rates are 0.50% and 3 month LIBOR is currently about 0.625%. The Short Sterling futures strip could rally a long way to achieve convergence.

Of course economic data could suddenly pick up, or the ONS measure of GDP could be revised higher, but on current data, a bull convergence prior to maturity looks most likely.

The Technical Trader's view:

WEEKLY CHART MAR 2011 CONTRACT

The chart of the short-sterling futures contract is powerfully constructed as the market ratchets better on successive highs as they act as support.

DAILY CHART MAR 2011 CONTRACT

The continuation Head and Shoulders pattern in the March 2011 has completed and is set to drive the market a good deal better still.

The minimum move? About 98.45.

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