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Daily Observations: Long GBP-crosses are Appealing

Daily Observations: Long GBP-crosses are Appealing

2015-05-13 14:45:00
Christopher Vecchio, CFA, Senior Strategist
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There's a case to be made for buying weakness in the British Pound, should it materialize in the wake of the Bank of England's May Quarterly Inflation Report. The BoE's QIR seemed a touch too dovish given the context of the current economic and political environment, which just saw a major short-term hurdle removed with the Conservative Party achieving an outright majority in parliament: there won't be a protracted period of negotiations between parties struggling to achieve a minority government with a weak mandate.

Political stability at home may eventually foster the conditions for the long-promised 'Brexit' vote, but that's beyond the scope of the current trading environment (that figures to be a factor in 2016, perhaps Q4'15 at the earliest). Our focus for now is on the interest rate environment, which sees that traders are pricing in the first BoE rate hike to come in March 2016, per the Sterling 90-day options (implied probability is 51.8%).

If the economy isn't going to take a step back as the BoE believes it will (per the downgraded growth and inflation forecasts released today), then there is room for interest rate expectations to be dragged further forward, providing a solid tailwind for the British Pound.

As recent as the first week of March, traders were pricing in December 2015 as the most likely period for the BoE to raise its key rate to at least 0.75%. I'm not making a case for the BoE to make its move then, but there is a void that has been created that can be filled (with the ground between the current March pricing and the BoE's mid-2016 expectation converging to earlier in Q1'16).

How might traders position for this repricing? Given the low rate environment, higher yielding currencies or those currencies in commodity-export driven economies seem most vulnerable (due to narrowing interest rate differentials). GBPCAD and GBPNZD are offering tantalizing long-term setups: GBPCAD has maintained its breakout from its February downtrend; and GBPNZD may be on the verge of a massive inverse head & shoulders formation (see the video in the linked article below for specific levels).

Read more: BoE Inflation Report a Minor Setback for Roaring GBP-crosses

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