A Contrarian Approach to Higher US Interest Rates

A Contrarian Approach to Higher US Interest Rates

Share market traders are familiar with the term "buy the rumour, sell the fact". It refers to a common phenomenon in stock markets. A share rises as its reporting date approaches, as investors and traders anticipate a positive report. The report day arrives, and the news is good. However, the share price falls, as profit takers overwhelm new buyers.

USD traders may be about to "sell the fact" on a global scale.

Next week, the US Federal Reserve Open Markets Committee will decide at its monthly meeting whether to lift US interest rates. Recent market volatility pushed market pricing of the probability of an September interest rate rise down to 30%. in my view, this is a gross underestimation of the Fed's often expressed desire to begin the process of interest rate normalisation, and a lift in rates next week is very likely.

Higher rates are supportive of a higher currency, and in anticipation of a rising interest rate environment traders have "bought the rumour", lifting the USD on a trade weighted basis by 25% since mid 2014:

US Dollar Index - Daily

20150911 dxy

The majority of traders do not expect a rate rise, and if one arrives, expect the USD to rise in response. However, the potential for a "sell the fact" response is evident, and offers a doubly contrarian play, selling USD. The attraction of contrarian plays is that when they pay off, they catch the market by surprise, meaning movement (and profitability) may be exaggerated.

I favour selling USD against pounds sterling through buying of GBP/USD. The Bank of England is also looking at an improving economy, and a potential rate lift, in contrast to the ECB and the BoJ which are still in easing mode. And there's a technical set up supporting the trade:

20150911 gbpusdA "V-shaped" bottom is in place, indicating a trend reversal. Note the cross in the MACD below the zero line, giving a buy signal. Some traders are buyers at current levels, others will wait for a move up through resistance around 1.5500. Either way, a long position in GBP/USD heading into the meeting beginning next Wednesday night may deliver a pleasant surprise.