Posted Thursday November 12, 2009 1430EST

Selling GBP/AUD on rate expectations

EUR/USD

Support

   1.7570 October 26 low

   1.7400 October 15 low

   1.7340 Lowest for the current down trend

Resistance

   1.7962 21-day sma/ possible broken bear flag base

   1.8150 Trendline resistance from the July high

   1.8370 November highs/55-day sma

Comments

Interest rate and growth outlooks are diverging in the G-10 economies, and nowhere is the divergence greater than between the UK and Australia. The strategy this week seeks to exploit a potential rebound in GBP/AUD as an opportunity to get short. Today's price action looks set to post a bullish hammer pattern, suggesting near-term potential for a recovery higher. Our expectations are that the RBA will continue to raise rates, although more slowly than previously expected, with the next hike coming on Dec. 1. We think the Bank of England will remain extremely cautious through the end of the year, based on its quarterly inflation report yesterday, and likely not be in a position to raise rates much before mid-2010. The main risk here is that the BOE announces an end to its asset purchases (quantitative easing) at its Dec. 10 meeting and triggers strength in GBP. The market consensus is shifting toward that view, so GBP may see some appreciation in the run-up. If the BOE maintains an 'open mind' on QE, then GBP will likely be hit. The timeline suggests caution after the RBA decision and before the BOE meeting. Otherwise, this trade should continue to be supported into the middle of 2010.

The drop in GBP after yesterday's quarterly BOE inflation report saw a quick drop in Cable, which broke below what may have been a counter-trend, bear flag consolidation in GBP/AUD. If, so the drop below suggests the downtrend may be resuming. Today's sharp rebound is testing near to that flag break level, which also has the 21-day sma at the 1.7960/70 level. The strategy will look to sell half of a short GBP/AUD position on strength at 1.8000, just below the Tenkan line, and the second half at 1.8140/50 trendline resistance from the July highs, for an average short rate of about 1.8070/80. The stop will be above the highs for November and the 55-day sma at 1.8400, for a total risk of about 330 pips. The take profit objective is for 50% at 1.7600, and the remaining 50% at 1.7350, just above the low for the year, for an average T/P rate of 1.7475. More conservative traders may wish to simply sell at current market levels and keep a tighter stop on a daily close above the potential bear flag break point at 1.7960/70, or if 1.8020/30 ever trades.