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US Dollar, Japanese Yen Poised to Continue Rallies

US Dollar, Japanese Yen Poised to Continue Rallies

2011-03-16 21:00:00
David Rodriguez, Head of Business Development
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Recent flare-ups in forex and broader financial market tensions have encouraged FX options traders to bet on and hedge against further US Dollar and Japanese Yen strength—pointing to further rallies.

The safe-haven Greenback and Yen stand to continue recent strength on continued market stress, and indeed our benchmark FX options risk reversals breakout-style system has hypothetically taken long positions in both the USD and JPY. Heavily one-sided Euro, British Pound, Canadian Dollar, and Australian Dollar positioning warn that Greenback recovery could prove especially sharp in said currency pairs. It will be critical to watch next moves in financial market risk sentiment, as deleveraging in one market would likely lead to similar moves in currency trading.

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

22.93%

35.71%

2.55%

76.34%

51.80%

21.52%

24.84%

1-Month

41.29%

54.29%

20.95%

74.45%

38.19%

28.48%

30.82%

3-Month

41.03%

80.85%

41.33%

69.39%

36.62%

27.10%

26.85%

12-Month

44.90%

94.03%

53.57%

57.03%

18.18%

22.60%

17.11%

DailyFX Volatility Index Percentiles

Volatility Index

1 Week

2 Weeks

1 Month

3 Months

1 Year

Indices

83.08%

84.62%

78.46%

58.46%

62.50%

US_Dollar_Japanese_Yen_Forecast_Strong_body_Picture_1.png, US Dollar, Japanese Yen Poised to Continue Rallies

Euro/US Dollar Options Analysis

US_Dollar_Japanese_Yen_Forecast_Strong_body_Picture_2.png, US Dollar, Japanese Yen Poised to Continue Rallies

CFTC Commitment of Traders data now shows that Non-commercial traders are the most net-long the Euro against the US Dollar since 2007, increasing risks of material correction through near-term trade. All the while, FX Options Risk reversals show that many have moved swiftly to bet on and hedge against continued Euro weakness. The sudden spike in volatility expectations warns that broader market deleveraging could force many traders to exit Euro-long positions and force the EURUSD lower.

Sentiment extremes are only clear in hindsight, but the fact that we have already seen the Euro pull back materially from highs warns that further flare-ups in market tensions could cause a larger EURUSD sell-off.

British Pound/US Dollar Options Analysis

US_Dollar_Japanese_Yen_Forecast_Strong_body_Picture_3.png, US Dollar, Japanese Yen Poised to Continue Rallies

The British Pound is at similar risk of further corrections as speculative positioning remains heavily net-long the GBPUSD. Several weeks ago we wrote that Non-commercial positions had hit their most net bullish levels since the pair traded above the 2.00 mark, and such one-sided positioning warned of sentiment extremes. We have since seen the British Pound fall noticeably off of peaks and indeed COT data shows leveraged futures positioning has likewise moderated.

FX Options risk reversals show that many have moved to bet on and hedge against further GBPUSD strength, and indeed our Breakout-style risk reversals system hypothetically closed an existing long position at a modest loss through recent trade. We view risks of a material British Pound pullback as high, and indeed several analysts have called for short positions in their daily analyst picks.

US Dollar/Japanese Yen Options Analysis

US_Dollar_Japanese_Yen_Forecast_Strong_body_Picture_4.png, US Dollar, Japanese Yen Poised to Continue Rallies

Incredible Japanese Yen rallies have led options traders to aggressively hedge against and bet on continued USDJPY weakness. In fact our benchmark FX Options Risk Reversals breakout system hypothetically went short the pair as of March 15 at the 80.72 mark. CFTC Commitment of Traders data is only released on a delay, but as of last week Non-commercial positioning was in fairly neutral territory for the Japanese Yen. Such relatively neutral positioning suggests that there is a good room for further USDJPY short positions, and momentum certainly favors continued declines.

It is admittedly difficult to advocate short positions on the USDJPY as it trades near record-lows and there is real risk of Bank of Japan forex intervention. Yet sentiment and positioning suggest that the pair could continue lower.

US Dollar/Canadian Dollar Options Analysis

US_Dollar_Japanese_Yen_Forecast_Strong_body_Picture_5.png, US Dollar, Japanese Yen Poised to Continue Rallies

A dramatic US Dollar reversal against the previously high-flying Canadian Dollar could be the start of a larger correction as traders exit leveraged positions. In past weeks we have warned that net Canadian Dollar Non-commercial positions were at their most net-long since the pair neared an important bottom in late 2007. The material reversal suggests that we may have recently hit a bullish sentiment extreme in the Canadian Dollar (bearish in USDCAD), and indeed FX Options risk reversals show that many have begun to bet on and hedge against further USDCAD rallies.

Our benchmark breakout-style risk reversals trading signal hypothetically went long as of March 15 near the 0.9860 mark, and a further deleveraging across financial markets would likely force continued USDCAD rallies through the foreseeable future.

US Dollar/Swiss Franc Options Analysis

US_Dollar_Japanese_Yen_Forecast_Strong_body_Picture_6.png, US Dollar, Japanese Yen Poised to Continue Rallies

Traders have grown aggressively bullish the Swiss Franc as it continues to set fresh record-highs against the US Dollar. COT data shows Non-commercial traders at their most net-long the Swiss Franc (net-short the USDCHF) since December, 2009. FX Options risk reversals likewise show that many continue to aggressively bet on and hedge against further Swiss Franc strength (USDCHF weakness). It is very difficult to advocate for a USDCHF short position as the pair trades at record-lows, but we would need to see a material reversal in price to call for a reversal all the same.

Australian Dollar/US Dollar Options Analysis

US_Dollar_Japanese_Yen_Forecast_Strong_body_Picture_7.png, US Dollar, Japanese Yen Poised to Continue Rallies

A substantial pullback in the Australian Dollar suggests that the pair may have set an important top through recent trade, and a further deleveraging across financial markets would invite continued AUD weakness. We have argued that the AUDUSD was at risk of significant pullbacks as COT data showed net Non-commercial positioning at its most net-long since the pair set an important top in early 2010.

FX Options risk reversals are now at their most bearish in the past 90 days, and our benchmark breakout-style system has hypothetically gone short as of March 15 near 0.9910. We like the chances of success of said trade, as further flare-ups in market tensions would likely force many of those holding AUD positions to head for the exits—sparking continued weakness.

New Zealand Dollar/US Options Analysis

US_Dollar_Japanese_Yen_Forecast_Strong_body_Picture_8.png, US Dollar, Japanese Yen Poised to Continue Rallies

FX options risk reversals have grown aggressively bearish the New Zealand Dollar against its US namesake, pointing to further losses in the already-downtrodden currency. It serves to note that the NZDUSD comes into recent declines at far less bullish COT Non-commercial positioning than its Australian counterpart. That is to say, the NZDUSD has arguably less room to fall than the AUDUSD. Yet the net-takeaway is the same; further flare-ups in market tensions could spark further US Dollar gains.

Our benchmark breakout-style risk reversals system hypothetically went short the NZDUSD as of March 15 near the 0.7320 mark. Said trade has a reasonable chance of success if this is indeed the start of a broader USD bounce.

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

To be added to this author’s distribution list, send an e-mail subject line “Distribution list” to drodriguez@dailyfx.com

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