Friday, October 23, 2009

GBP/USD Rally RIP: Much Ado About Nothing from the Bank of England

OR: What Happens to Baseless Short Squeeze Moves

Last week the GBPUSD was the star fx trade of the week, moving up about 10% in 3 days. The beauty of this move was that it was – and remains as of this writing – as obvious a temporary short squeeze move up that could not sustain itself for long.

Why, as I wrote in my instablogs on Seeking Alpha, the pair moved up on the basis of a non-event. Bank of England officials simply noted that they would have to end stimulus and raise rates at some point in the future – no time limit given. This is just a restatement of the obvious. Yet it worked, for a short time.

Why? This kind of jawboning can work when the currency in question is extremely oversold, because the latecomers or other nervous sorts (or traders anticipating them) get scared and unwind their short position by buying back the currency. Once the ignorant and nervous are gone, the longer term trend resumes as everyone calms down and realizes that the move was much ado about nothing.

It also worked a few weeks ago when Fed officials did the same thing, just restating the obvious point that eventually they'd raise rates. The USD is (and remains) so oversold that any minor news like this can shake out some shorts.

Then too, however, everyone soon realized that any real support (i.e. cutting back stimulus, raising rates) was not on the way because the underlying economy is too weak to absorb such a move without getting worse. The dollar soon resumed its swoon as there was no reason to hold it.

What made this retracement of a nonsense rally even easier to call was that the GBPUSD pair quickly hit two important resistance points, as one can see on the below chart. First, it hit its upper Bollinger band, and has behaved fairly predictably whenever it has done so in the recent past. Note in the daily GBPUSD chart below, how quickly and steeply it tends to retreat when this upper band is hit.

Daily Chart GBPUSD as of Oct 23, 2009.

Note also how that upper band converged neatly near the 1.6700 price level, a strong resistance point in the past.

If these technical indicators weren't enough, there was the fairly predictably disappointing UK GDP reading today, and was more than enough catalyst to get the baseless recent rise of the pair in full retreat.

Looking at the chart, the pair is now sitting at near term support around 1.6390.

Any break below that level should present another safe entry point to short the pair. If stocks pull in, that would just make the trade that much more obvious, since the USD the pair tends to drop with stocks. As the chart shows, there's plenty of retracement left.

Disclosure: No positions held by the author in the GBPUSD.

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