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US Dollar Positioning Warns of Fewer Bets on Weakness

By , Quantitative Strategist
04 May 2011 14:45 GMT

Continued US Dollar weakness has not necessarily been met with continued bets on and hedges against further declines, warning that participation is waning as the Euro approaches the key 1.50 mark.

FX futures data shows that Non-commercial traders—typically large speculators—remain very heavily net-short the US Dollar across almost all major counterparts. Yet FX Options risk reversals have most recently been disconnecting from price, and it is increasingly expensive to bet on/hedge against aggressive USD gains. It is extremely difficult to catch a major top or bottom amidst such impressive one-way moves. Yet the growing divergence between options sentiment and US Dollar weakness warns against placing aggressive bets on USD weakness.

Watch a presentation on how you can use FX Options risk reversals and this report in your swing trades.

Risk Reversals

EUR/USD

GBP/USD

USD/JPY

USD/CAD

USD/CHF

AUD/USD

NZD/USD

1-Week

51.79%

4.44%

47.54%

92.98%

20.00%

8.33%

8.93%

1-Month

72.22%

76.00%

55.17%

69.81%

25.81%

10.00%

11.76%

3-Month

59.65%

67.39%

63.64%

77.19%

29.82%

12.50%

14.55%

12-Month

72.73%

95.45%

75.93%

85.11%

53.57%

23.21%

63.64%

DailyFX Volatility Index Percentiles

Volatility Index

1 Week

2 Weeks

1 Month

3 Months

1 Year

Indices

93.85%

92.31%

88.89%

92.31%

95.31%

forex_us_dollar_forecast_body_Picture_1.png, US Dollar Positioning Warns of Fewer Bets on Weakness

Euro/US Dollar Options Analysis

forex_us_dollar_forecast_body_Picture_2.png, US Dollar Positioning Warns of Fewer Bets on Weakness

The Euro continues to power to fresh highs against the US Dollar as futures traders pile onto their long positions, but an important pullback in FX Options risk reversals suggests that fewer are betting on and hedging against further strength. Commitment of Traders data shows Non-Commercial futures traders at their most net-long Euros since the pair rallied towards 1.60 in 2007. The disconnect between futures and options sentiment nonetheless warns that participation is growing increasingly thin.

One thing remains clear: one-sided leveraged bets warn that the Euro/US Dollar could see a material correction on a flight to safety across financial markets. As traders rush for the exit we could see the Euro drop across the board. Timing the reversal has nonetheless continued to elude us, and we see little option but to remain bullish absent signs of a major correction.

British Pound/US Dollar Options Analysis

forex_us_dollar_forecast_body_Picture_3.png, US Dollar Positioning Warns of Fewer Bets on Weakness

A noteworthy pullback in the British Pound has been met with a similarly pronounced correction in FX Options risk reversals, suggesting some have shifted towards betting on and hedging against GBPUSD weakness. Our benchmark breakout-style risk reversals system hypothetically went long the GBPUSD as of April 21 at approximately the 1.6520 mark, but that position would have been closed today at roughly breakeven. FX Futures positioning remains modestly net long.

The sharp turnaround in GBPUSD risk reversals suggests market sentiment may have turned on the British Pound, and we will wait to see whether we see a bigger turnaround before calling for a sharper US Dollar bounce.

US Dollar/Japanese Yen Options Analysis

forex_us_dollar_forecast_body_Picture_5.png, US Dollar Positioning Warns of Fewer Bets on Weakness

Speculative futures positioning in the Japanese Yen remains near its most bearish (bullish USDJPY) in the past year, underlining the sudden deterioration in sentiment for the safe-haven currency. The USDJPY has all the same continued to hit multi-week lows, while FX Options data shows risk reversals are roughly neutral compared to their 90-day trading range. Given such mixed signals, we have little conviction in our USDJPY forecasts and remain neutral until clarification in sentiment.

US Dollar/Canadian Dollar Options Analysis

forex_us_dollar_forecast_body_Picture_4.png, US Dollar Positioning Warns of Fewer Bets on Weakness

A significant divergence between Canadian Dollar price action and FX Options risk reversals warns that gains (USDCAD losses) could soon reverse. The disconnect with risk reversals suggests relatively few are betting on or hedging against further Canadian Dollar strength (USDCAD weakness). Timing reversals amidst such drawn out moves is extraordinarily difficult. Yet the significant divergence warns against chasing USDCAD weakness.

Futures positioning likewise shows Non-commercial traders near their most net-long Canadian Dollars (short USDCAD) since the pair set a short-term bottom through March. A sudden deleveraging across financial markets could force a significant short-covering rally in the USDCAD.

US Dollar/Swiss Franc Options Analysis

forex_us_dollar_forecast_body_Picture_6.png, US Dollar Positioning Warns of Fewer Bets on Weakness

Traders remain aggressively bullish the Swiss Franc as it continues to hit record-highs against the US Dollar. COT data shows Non-commercial traders remain heavily net-long the CHF (short USDCHF), while our benchmark FX Options risk reversals system has hypothetically remained short USDCHF since March 17. It is nonetheless interesting to note that recent Commitment of Traders data shows Non-Commercials have scaled back CHF long positions (USDCHF shorts) despite fresh highs. We could hardly advocate establishing USDCHF long positions amidst extremely one-sided momentum, but the growing divergence in sentiment and price warns against chasing USDCHF weakness.

Australian Dollar/US Dollar Options Analysis

forex_us_dollar_forecast_body_Picture_7.png, US Dollar Positioning Warns of Fewer Bets on Weakness

The Australian Dollar continues to defy calls for a sustained pullback, rallying sharply after initial signs that it could continue lower through recent trade. Net non-commercial futures positioning is now just below its most bullish on record, emphasizing that we are seeing unprecedented times for the Australian Dollar.

FX Options Risk Reversals have not matched futures positions, however, warning that participation in rallies is waning. Such a divergence warns against aggressively chasing AUDUSD gains. Yet the true sentiment extreme and high in price is only clear in hindsight, and we are reluctant to advocate short positions until clearer signs of potential reversal.

New Zealand Dollar/US Options Analysis

forex_us_dollar_forecast_body_Picture_8.png, US Dollar Positioning Warns of Fewer Bets on Weakness

As with the Australian Dollar, New Zealand Dollar positioning and sentiment shows noteworthy divergence between FX futures and Options sentiment. Futures speculators are now their most net-long the New Zealand Dollar since the pair pulled back from a medium-term top through February. A very sharp deterioration in risk reversals suggests that many have shifted to bet on and hedge against continued weakness. A further drop would lead our breakout-style FX Options risk reversals trading system to hypothetically establish a short position.

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

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04 May 2011 14:45 GMT