Key Highlights:
- CAD weakest as front-end yield premium to US vanishes
- UK Inflation hits 5-year high, but Carney tempers rate hike expectations and GBP Bulls
- Potential Fed Chair John Taylor boasts Mon Pol model that sees more aggressive Fed
- IGCS Highlight: EUR/USD 13% increase in short positions w/w warns of upside continuation
Strong Weak Analysis is a way to identify momentum in the FX market. Trend traders rely on spotting and riding momentum as it develops and looks to benefit from trends extending, as many do. It’s also worth noting when the strength of a trend is waning, which Strong Weak analysis can also benefit.
Each day will bring you an index of strong and weak currencies as identified via the methodology in our article, ‘How to Create a "Trading Edge": Know the Strong and the Weak Currencies.' I will also share with you sentiment developments via IG Client Sentiment that can provide additional insight to help you decide what trends could extend.
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Strong/ Weak Index October 17, 2017
Created by Tyler Yell, CMT
Highlights:
-The Canadian Dollar remains the weakest currency and headlines on Tuesday morning added to the pain. CNBC reported that Canada and Mexico are expected to reject U.S. NAFTA proposals though they will offer to keep negotiations ongoing. Before the CNBC report, the spread between the 2-year sovereign yield of US and CA bonds flipped from being in favor of Canada to the US for the first time since early September. The relationship of the yield spread held a near perfect positive correlation to the USD/CAD spot rate in the previous month. Canada’s short-term yield premium to the US 2-year yield peaked on September 8 at ~26bps and now is in the US’ favor by 3bps. The Canadian Dollar has weakened by 2
-The US Dollar continues to broaden its strength on news that Stanford Professor of Economics, John Taylor has a higher likelihood of becoming the next Fed chairperson than previously thought. The often-praised Taylor economic model, which is lore among macroeconomists says the Fed should be much tighter than they currently are with rates at 1.25%. The view that Taylor could take the helm at the Fed has sent front-end yields higher flattening the curve while the USD surged. Since news of Taylor impressing US President Donald J Trump, the price of USD/JPY has shown quick reaction higher by ~0.5%.
-The British Pound failed to hold gains despite UK inflation hitting 3% y/y, the highest levels since 2012. The odds for a Bank of England rate hike remain near 80%, but GBP failed to hold the gains as high-strike GBP premiums are fading, which would argue that GBP gains and BoE pressure is likely a shorter-term phenomenon. Currently, the view in derivatives markets is that the next hike from the BoE will likely not be followed up by another hike anytime soon as consumer spending has been struggling as the economy slowed making it difficult to hold a long-term Bullish GBP view.
-The price of USD/JPY looks to finally be reflecting the broader risk-on sentiment as seen with the Nikkei trading at the highest levels since 1996. A key reason for this can be seen in the premium for JPY calls receding ahead of the October 22 election. When PM Shinzo Abe called for a snap election to increase the LDP ruling coalition, JPY began to strengthen (JPY-crosses lower) as puts on JPY crosses and JPY calls became bid with an expiry around October 22. Such a development was key in seeing a cap on USD/JPY rising despite broader risk sentiment. Recently, reports from Japan’s media are showing an increased likelihood that the Abe administration will strengthen its grip on power the options premium for JPY strength has come off, and a continuation of this trend could lead to further increases in JPY-crosses.
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IGCS Highlight: EUR/USD 13% increase in short positions w/w warns of upside continuation
EURUSD: Retail trader data shows 41.0% of traders are net-long with the ratio of traders short to long at 1.44 to 1. In fact, traders have remained net-short since Apr 18 when EURUSD traded near 1.08123; price has moved 8.6% higher since then. The number of traders net-long is 3.9% higher than yesterday and 1.5% lower from last week, while the number of traders net-short is 4.2% lower than yesterday and 13.6% higher from last week.
We typically take a contrarian view to crowd sentiment, and the fact traders are net-short suggests EURUSD prices may continue to rise. Positioning is less net-short than yesterday but more net-short from last week. The combination of current sentiment and recent changes gives us a further mixed EURUSD trading bias.
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Written by Tyler Yell, CMT, Currency Analyst & Trading Instructor for DailyFX.com
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