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Busch: Great Expectations and the ECB

Wednesday, 4 May 2011 | 12:20 PM ET

The FX markets are pummeling the US dollarstrength as we head into tomorrow's ECB and Bank of England meetings.

All periphery European CDS fell hard today with Portugal down 5.2% and spreads to German debt narrowed as well.

If the European debt situation has stabilized, the market believes that this will unshackle the ECB to raise rates faster.

Also, we had today another Fed member state there's no reason to raise rates and a soft ADP number that is supporting the overall sell the buck mojo.

However, there is an outside risk that the ECB is aware of this increase in expectations and will verbally do something about it. Typically, the pattern to the chatter out of the ECB has been to raise expectations for rate hikes, hike rates, then back down expectations for further hikes. I expect a more dovish discussion tomorrow from ECB President Trichet on how many rate hikes will be coming and when those rate hikes may occur.

Here's how I would take advantage of this scenario and it's what I discussed on CNBC's Squawk on the Street today:

Stock markets are looking wobbly ahead of Friday's US unemployment and risk off should dominate until the release.

Both the ECB and BOE meet tomorrow and are expected to keep rates unchanged.

The ECB raised rates last time by 25 bp to 1.25% and BOE left rates at 0.5%.

After the ECB raises rates, the next meeting they usually leave rates unchanged and then they talk dovishly to back down expectations for further rate hikes.

The risk is that the BOE has to address rising inflation and we may get a surprise close vote of 5-4 to raise rates.

The trade: Sell Eur/Buy Gbp

  • Entry at 0.9025
  • S/L at 0.9075
  • T/P at 0.8675
  • 6:1 return

Three things to remember:

  1. You can always adjust the parameters to get in and out.
  2. This is a short term trade with low amount of points risked.
  3. To reduce time frame risk, you can put trade on just before the meetings.

Andrew B. BuschDirector, Global Currency and Public Policy Strategist at BMO Capital Markets, a recognized expert on the world financial markets and how these markets are impacted by political events, and a contributor to CNBC's Money in Motion Currency Trading.You can comment on his piece and reach him hereand you can follow him on Twitter at http://twitter.com/abusch .

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