A real drama is playing out in the UK market this morning. At 9:30 we had an inflation print well above expectations, with the consumer price (CPI) hitting 3.1% year on year. Also worth noting, is the retail price index (RPI), the UK’s traditional measure of inflation and the measure which wage negotiators use, and to which most other inflation related payments are related. The RPI rose by 4.8% year on year. (The market was looking for a 2.8% print on the CPI and 4.6% on the RPI). These really are staggering figures, so get ready for the newspaper headlines. Higher interest rates are definitely on the cards.
Also, because the CPI has breached 3.0%, the Bank of England has had to write a letter of explanation to the Treasury, and as it’s the first time this has happened since the central bank became independent, the event will likely garner more attention than it warrants, but its something for the media to talk about, and talk they must.
What’s more interesting from my perspective, is the minute-by-minute price action following the inflation print:
In the ten minutes after the inflation report, cable was consolidating just shy of the 2.0 handle, floating around 10 pips below the big figure. The economic data was so strong, however, that I figured the market was collectively just biding it’s time before breaking north of the big figure. From experience, when cable breaks through round numbers that haven’t been seen in a while, the currency can see a flurry of buying (or selling) as stops are taken out. So, what happened this time around? Well, cable popped above 2.0 at 9:44 a.m, hitting 2.003. This lasted for few seconds before the currency got slammed lower, falling some 25 pips within a minutes. This is not normal.
After watching the market for years, I find this kind of price action most peculiar. Traders have to have views, and my reading of this historic event is that a large participant or group of participants don’t want 2.0 to break and they are willing to place very large orders to prevent it happening. It’s useless fighting the tide, in my opinion. But it tells me, and others, that the orders above 2.0 could be massive. Has somebody shown their hand and revealed their weakness? Perhaps. Hah, as I write this, cable has moved sharply higher again, and is at 1.9999. What a drama.
Afterward: After proof-reading this piece, cable has been taken sharply lower again. I expect this volatility to persist but I’m about 70/30 in favour of a break above 2.0. It’s going to be a war now, with players gunning for the stops. Why do I believe participant(s) might want to ‘protect’ a certain level from being hit? As well as a large number of stops being placed around the 2.0 handle, I expect there are also a large number of option barriers and the like around this level. With these types of derivative products, a counterparty has to cover their position and pay out in the event of a price reaching a specified target. Only a year ago, cable was around 1.70, and a few years prior it was below 1.50. I can imagine how 2.0 would have seemed a near impossibility back then, and that it could have been very attractive proposition to cheapen financing deals or other structures by adding in an option element whereby the holder loses if 2.0 is breached. This is just one example of the kind of beast that may be lurking out there. But you can see why some people may want certain levels not to get taken out. Unfortunately, I don’t think they can help it. Has the marked smelled blood?