US Dollar Forecast Turns Short-Term Bearish on Sentiment Extremes

Forex options and futures market sentiment has shifted substantially through the year-end US Dollar reversal, and clear USD-bullish extremes suggest gains may slow through short-term trading. Indeed, speculative futures traders are now the most net-long US Dollars against the Euro since the EURUSD bottomed through late 2008, and a similar correction could see the EURUSD bounce substantively off of recent lows. Yet the speed at which markets have reversed suggests that the overall tide has turned, and the longer-term favors continued US Dollar strength into 2010.

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Forex options markets volatility expectations have jumped considerably through recent trade and favor large price moves in the coming week of trade. Certainly the upcoming US Nonfarm Payrolls report has influenced volatility forecasts, and it will be important to watch the US Dollar’s reaction to the highly market-moving economic report.

Forex futures and options sentiment in the Euro/US Dollar has seen a fairly substantial reversal through the past months, going from bullish to bearish extremes with impressive speed. Speculative futures positioning is now at its most net-short since the Euro bottomed near 1.25 in late 2008 and underlines the aggressive shift in trends. At the same time, Forex options risk reversals have bounced back considerably from recent bearish extremes. All in all, the abrupt shift suggests that the longer-term tide has turned in the USD’s favor. Yet the short-term picture warns of a EURUSD bounce.

Forex futures positioning has become increasingly net-short the British Pound against the US Dollar through recent trade while forex options markets are similarly bearish the GBP.  Indeed, Risk Reversals had recently reached their most GBP-bearish levels since the pair traded near the 1.4000 mark. Their recent bounce signals that we may be in for further short-term GBPUSD corrections, and a close above the pair’s 200-day Simple Moving Average at 1.6095 would signal risk remain to the topside through upcoming trade.

Japanese Yen positioning is currently at clear bearish extremes with forex options market risk reversals at their most bearish (bullish USDJPY) in approximately a year. This leaves the US Dollar/Japanese Yen pair at fairly clear risk of a pullback, and the recent turn lower in price suggests we can see further USDJPY declines. Indeed, a hold of the 61.8% Fibonacci retracement of the pair’s 97.80-84.80 move at 92.80 leaves our short-to-medium-term bias to the downside.

Forex options and futures markets remain quite bullish the Canadian Dollar against its US namesake, leaving the door open for further short-term USDCAD declines. Several months ago we claimed that the USDCAD was likely to bounce substantively on clearly one-sided USDCAD-bearish sentiment. Positioning has since moderated, however, and there is once again scope for Canadian Dollar appreciation. Short-term momentum favors further USDCAD declines and we remain bearish until further notice.

Non-Commercial futures positioning on the US Dollar/Swiss Franc pair recently hit its most bearish in nearly 5 years—pointing to clear sentiment extremes. A sharp US Dollar reversal produced a flip to net-long and underlines the aggressiveness of the recent USD recovery. Despite the shift, however, futures positioning is not at any major extremes. Forex Options markets risk reversals actually hit bullish extremes and have pulled back through more recent trade. Relative indecisiveness gives us little bias on the USDCHF pair.

Short-term Australian Dollar forecasts suggest the pair may bounce from recent lows, but overall positioning favors more long-term weakness. Australian Dollar forex options and futures positioning had previously hit substantial bullish extremes, and we called for a noteworthy pullback. Yet sentiment has thus far moderated considerably, and options risk reversals are actually closer to bearish extremes. Watch for risk of short-term bounces, but our longer-term remains bearish on a potential unwind of Australian Dollar long positions.

The New Zealand/US Dollar pair is quite similar to the AUDUSD, with significant sentiment extremes leaving the door open for longer-term declines. Yet the AUDUSD has clearly outperformed, and traders have begun pulling back from their previously one-sided NZDUSD positioning. Overall forecasts are similarly bearish, but watch for a near-term bounce.

Written by David Rodríguez, Quantitative Strategist for DailyFX.com, drodriguez@dailyfx.com