In the following article, based on the Commitments of Traders report, I deconstruct last week’s change in futures and options positioning. Note, notwithstanding the insights one can obtain in the data from Aug 29th to Sept 4th, in this week’s analysis, I also emphasize the consequences in market positioning following what might have been a watershed moment to re-price a more aggressive Fed tightening cycle heading into 2019, as the latest CoT data still doesn’t capture these changes until next Friday.
In a nutshell, the psychological break of 2.8% y/y in US wage growth, as part of yet another strong US NFP number last Friday, especially if backed up by a positive US CPI on Thursday, should constitute the stroke that breaks the camel’s back in terms of renewed macro interest towards the US Dollar.
The latest data, up to Sept 4th, was fairly inconclusive, except in the Australian dollar market, which was unambiguously bearish. After the US NFP on Friday, we can now safely assume that some of the bearish USD positioning that was being built, as is the case of a rather bullish EUR report, will now have to be re-assessed, which may lead to potentially trap wrong-sided EUR longs (DXY shorts) ahead of next Thursday’s ECB meeting, when all the bets will go off and the euro’s next direction will be determined by policy outcome.
Meanwhile, the current dynamics in the sterling and Japanese yen markets, one driven on a Brexit headline-by-deadlines basis, and the other as a function of risk-off flows, makes the anticipation of a potential directional bias not as convincing. However, it definitely suggests that positive GBP, JPY flows will struggle to make as much progress, as a re-allocation of capital is expected to join the US Dollar bandwagon in anticipation of a more hawkish Fed.
Main Takeaways from the Euro Contract (6E – CME)
- Price decreased with the open interest picking up from 615k to 622k. Even if at first sight it suggests renewed commitment to engage in sell-side business, the major reduction in large specs short EUR, which were cut by 15k, comes in stark contrast and communicates the drop had no interest by the smart money community, which often leads to a reversal in prices.
- We saw a significant increase in commercial short positions from 300k to 320k, reinforcing the notion that 1.17 becomes a level of value to hedge.
- Dealer shorts kept adding business on the way down, taking their total positioning from -75k to -95.5k approximately, which is further evidence that despite the decline in the exchange rate, the need to hedge long-side investment products in the EUR is high and it implies a market that should continue to find plenty of demand. Note, the outlier wage growth reading in the US last Friday, at 2.9% y/y may see dealers’ positioning re-adjusted and greater need to hedge supply-related activities, given that the data is likely to represent a macro shift in investors views towards the USD in order to reflect a re-pricing of a tighter Fed hiking cycle.
- In line with the macro trend in this category, asset managers activity saw an increase in total long positions, a move that would have raised even more red flags as a bullish EUR sign if it wasn’t for the strong US wage growth figures, which made the market re-evaluate its positioning.
- Overall, the reading of last week’s positioning is quite interesting, as it clearly shows a market that was preparing for a higher valuation, potentially anticipating the poor outlook for Aug US NFP, but was caught on the wrong-sided, as the risks have now shifted towards 1.15 and below.
Main Takeaways from the Sterling Contract (6B – CME)
- The open interest in the sterling market ticked up, with the overall volume increasing against the prior 5 days of CoT data. The move, however, failed to attract an increase of sell-side interest, partially led by the flush out of shorts on Aug 29th based on positive Brexit headlines which most likely led the market to re-assess their overly pessimistic assumptions.
- Commercials increased their short exposure by over 6k as the price tested the 1.30 round number, while on the way down, there was no interest by commercial longs to add new business.
- The move higher in the sterling does not communicate an increase in the overall demand dynamics, given the absence of dealer shorts, which actually went from 5.3k to 4.4k, suggesting that the move was very much a removal of liquidity, coupled with shorts bailing out, but it so far doesn’t reflect in the data as having caused a change in perceptions. The lack of short hedging by dealers means the interest to allocate GBP buy products in coming weeks and months remain at very depressed levels.
- We saw quite a bit of activity by asset managers, with both long and short adding positions, the latter being more aggressive by over 2k.
- To sum up, the market appears to be indecisive on what direction to take next, with short-term and erratic movements on brexit headlines to drive prices. As such, it is no surprise that we didn’t see an increase in demand dynamics via higher short dealers, while at the same time, the lack of renewed sell-side interest by large specs also hints at a market not as committed to playing shorts, especially considering the recent sudden spikes in the value of the sterling. Under this type of environment, traders should remain short-term volatility dependent.
Main Takeaways from the Japanese Yen Contract (6J – CME)
- There was no net change in open interest, while the volume was a tad higher. By looking at the large specs community, there was an addition of yen shorts, as the US dollar made a push higher towards 111.50. The up move in USD/JPY on the week proved rather limited in nature as yen longs took full control again as risk-off flows persisted.
- The change in activity by commercials was not particularly insightful, partly owed to the fact that the price remained confined in a narrow range, which made the need to hedge positions by commercials less compelling.
- The net increase in dealer longs continues to endorse the idea that mid to long-term, barring any prolonged surprises such as the continuous hammering of prices due to risk-off flows, the market is betting for a higher US dollar vs yen, with demand dynamics for the yen quite poor. However, note dealers tend to be extremely quick to flip their exposure in case of any shockers in fundamentals, but as of now, and bearing in mind the latest increase in US wage growth on Friday, one would expect a re-adjustment of dealers’ positioning to reflect an even more bullish stance in the US dollar.
- The asset managers activity was very thin with no changes of note. As in the case of commercials, the lack of price volatility kept them sidelined.
- Overall, it was a rather non-committal week to gain new insights, which tends to be the case when the price is encapsulated in a small area as was the case. In the grand scheme of things, with the bonanza in the US economy in stark contrast with the stagnant outlook in Japan, the monetary policy divergence between the two countries should continue to favor the upside in US dollar vs yen, barring major episodes of risk aversion.
Main Takeaways from the Australian Dollar Contract (6A – CME)
- By far, the currency that offers the most bearish picture is the Aussie, with open interest the highest in years after another substantial increase of nearly 20k positions, in a week that saw the rate collapse about 200 pips.
- The leverage specs community added shorts, approaching the highest net short levels of the year. There is room for the rate to transition into lower levels if one takes into account that large specs have reached extremes of over 70-75k as was the case in 2015 vs the current -49k total positions.
- The hammering of prices was perceived as an opportunity for commercial accounts to add longs, although when analyzing the total change, the increase in commercial shorts was quite notable too, even if the data analyzed saw no bounces at all and was pretty much a one-way street. Given the increase in open interest, the total percentage of commercials vs total open interest has come down from nearly 50% to 40%, which strengthens the case to see further falls on the easing of extreme reads.
- The relationship between dealer longs and shorts continues to point at a market that remains unambiguously short, with the imbalances in supply dynamics far exceeding the demand. As a full-blown trade war between the US and China edging ever closer, the Aussie is expected to stay under pressure as the favorite proxy to play the emerging markets and risk trade.
- If one needed further confirmation on the bearish view, the latest move captured by the CoT data saw asset managers increase their net short exposure by -27k to -30.3k, which makes the hypothesis to see plenty of selling interest on any bounce even stronger.
- To sum up, the CoT indicates the Aussie is a currency that should remain extremely vulnerable against the US dollar, therefore any bounces in price at regular intervals should see the supply-imbalance dynamics to persist.
How to Be Positioned Going Forward?
Barring any major shocker in the trajectory of the US economy, or a rather unexpected positive resolution in the US vs China trade war, the conditions look set for the USD to benefit against G4 FX, although some nuances must be duly noted. Against the Australian dollar, marginal rebound sequences as well as extended in nature should continue to find committed sellers at regular price intervals, making a sell on rallies the preferred strategy. Selling strength in the euro vs US dollar is also expected up until Thursday’s ECB policy meeting when a general re-assessment of the euro attractiveness will ensue; however, judging by the positioning of the market ahead of the US NFP, the euro is still seen as quite an attractive proposition although trapped buyers may suffer near term. The sterling and the yen, when all factors considered, should see the directional bias skewed towards the downside against a stronger US dollar, even if I must emphasize that the risks of being whipsawed on political events (GBP) or risk sentiment (JPY) remain elevated.
- Volume & OI: Open interest represents the total number of contracts, including both buy and sell positions, outstanding between all market participants. We should think of open interest as new business (additional liquidity). Open interest is closely linked to liquidity. Generally, to gain conviction over a potentially developing bullish market, we could analyze whether or not open interest increases, new buyers coming in, which fuels the continuation higher on renewed commitment, ideally replicated by volume increasing or at least maintaining a steady measure. If on a bullish market, the open interest is decreasing, it has a different meaning all together, suggesting shorts covering, players stopped out, and hence money is leaving the market. This information to understand move dynamics is key.
- Large Specs:The Net Non-Commercial Positions, often referred as Large Specs, comprise contracts held by large speculators, mainly hedge funds and banks trading currency futures for speculation purposes. Speculators, for the most part, have no need to use the futures market as hedging, with the sole intention being speculative in nature, buy or sell at a profit, before the contract becomes due. This category tends to carry large positions and are often guided by fundamental developments. Historically, they are characterized by being trend-followers and tend to get the right directional bias.
- Commercials:Entities that are commercially engaged in business activities hedged by the use of the futures or option markets. The main characteristic of this group is that their activity orbits around the need to buy or sell the underlying contract to minimize the risk of exchange rate variations in the future. Like the large specs, this group also tends to carry large positions at times and due to the hedging nature of its activity, act as contrarian traders, best buying when prices are low and vice versa.
- Dealers: These participants are typically described as the “sell side” of the market or net hedgers. They don’t take positions to speculate for profits, but instead design various financial strategies to allocate assets to institutional clients. They help us understand supply and demand dynamics and act as liquidity providers and tend to have matched books or offset their risk across markets and clients. Futures contracts are part of the pricing and balancing of risk associated with the products they sell and their activities. These include large banks (U.S. and non-U.S.) and dealers in securities, swaps and other derivatives. These participants track very closely the open interest.
- Asset Managers: These are institutional investors who tend to act slowly in established trends, which include pension funds, endowments, academic institutions, insurance companies, mutual funds and those portfolio/investment managers who predominantly represent institutional clients. Their performance is based on the average of the industry, not in the business of taking contrarian positions and/or changing their macro view that often.
- Leveraged Funds: These are typically hedge funds and various types of money managers, including registered commodity trading advisors (CTAs); registered commodity pool operators (CPOs) or unregistered funds identified by CFTC. The strategies may involve taking outright positions or arbitrage within and across markets. The traders may be engaged in managing and conducting proprietary futures trading and trading on behalf of speculative clients.