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Using Secondary Indications in Your Market Analysis

Yesterday Adam at Forex Blog put up a blog post looking at the British Pound, specifically in terms of GBP/USD. He throws a lot of different stuff into his assessment of the UK currency, part of which is looking at the prospects for a rate hike by the Bank of England. To that end, let me share two charts I keep an eye on in my work.

This first chart shows the spread of UK 2 year Gilt rates over the US 2yr Treasury Note rate, with the spread’s correlation to GBP/USD in red as the lower plot.

The second chart is the same as the one above, but swapping German Bunds in place of US Treasuries and running the correlation against EUR/GBP instead of GBP/USD.

I offer up these charts for a couple of reasons. One is to show the sort of secondary analysis professionals use to assess the markets. Another is to show how frequently market correlations can change. We would expect a positive linkage between the UK/US rate spread and GBP/USD and a negative one between the UK/German spread and EUR/GBP, but that’s not always the case.

The third reason for showing these charts is to show what’s been going on in these spreads lately. The UK/German spread has fallen sharply, strongly indicating the market’s view on whether it will be the ECB or BoE the moves first to hike rates has moved strongly in favor of the former. Things are less dramatic in the UK/US spread, but the breakdown there hints that fixed income traders have become less confident about a BoE rate move in the short-term in general, not just as opposed to the timing of the ECBs action. These are the sorts of things the professionals are looking at and thinking about in making their market judgements. It’s all related.