Sterling unwinds most of BOE-inspired gains, but rates market does not - BBH

"Sterling peaked on September 20 near $1.3660.  It traded to nearly $1.3220 today.  It has fallen in nine of the past dozen sessions.   The main culprits are the broader US dollar recover, disappointing UK data, and perhaps some Brexit anxiety, spurred by the continued hardline push by Johnson," note analysts at BBH.

Key quotes:

"With today's loss, sterling had practically returned to the lower end of the range seen on September 14 when the minutes and comments around the MPC meeting was considerably more hawkish than expected.  While the currency has corrected, interest rate expectations remain elevated.  The implied yield on the December short-sterling futures contract rose from about 38 bp at the start of the week that the BOE met to  56 bp on September 20, when sterling peaked.  The implied yield currently is near 53 bp."   

"In fairness, sterling's advance did not begin with the hawkish BOE, but the latest leg up began in late August when sterling was trading near $1.2775.  The central bank's hawkishness came late in the advance and market only the final leg of it.  The decline over the better part of two weeks has retraced 50% of the gains since late August (found near $1.3215).  The 61.8% retracement is near $1.3110."   

"Adding to the negative technical tone is the five-day moving average falling through the 20-day average for the first time since early September.  Trend following and momentum models often using some combination of moving averages and we use the five and 20 as a broad proxy for such participants, even though they may use other moving averages, and in combination with other indicators.  Looking at the other technical indicators, we see the Slow Stochastics have turned down hard, while MACDs have crossed over more recently.  That said, if sterling met the 50% retracement objective of the rally from late-August, it could post some corrective gains.  The initial target would be around $1.3350, which corresponds to last week's lows."

"Meanwhile, Brexit issues continue to percolate.  Johnson pushes for a hardline and then capitulates to the Prime Minister's position.  Today, the European Parliament confirmed the impression from the EU negotiators, which despite May's recent speech and the formal suggestion of a transition period, the talks are not ready to proceed to the next phase.  Specifically, the European Parliament voted 557 to 92 (29 abstentions) to postpone starting the new phase at the EU Summit on October 19."   

"Ironically, some in the UK government reportedly hoped that if the FDP were part of the new German government, Brexit negotiations could go a bit easier.  It does look like the FDP will be in the governing coalition, and it might even get to have one of its members, perhaps the party leader, replace Schaeuble as finance minister.  However, it is not clear, and won't be for some time, whether the FDP changes the EU's negotiating position."  

"Speculative positioning in the futures market is skewed by the contract roll (from September to December), but as of last Tuesday, the speculators were net long sterling in the futures market for the first time in nearly two years.  At the end of August, speculators were net short 51.6k sterling futures contracts.  As of a September 29, they were near long nearly 5.1k contracts.  In the latest reporting week, speculators covered 11.6k previously sold contacts.  The gross short position fell by a third to 75.1k contracts over the past two reporting period.  The speculative gross long position rose from 60.1k at the end of August to 80.1k as of last Tuesday.  It is the largest gross long position I three years.  The large short speculative sterling position that may have discouraged new shorts earlier has been corrected."