The extremes in this week’s CFTC data are the same as last week: long euro, British pound and Canadian dollar positions and short US dollar. This is shown below:
CFTC COT (futures & options combined) – October 10, 2017
Notable extremes are bolded, and are highlighted when speculator positioning is more than two standard deviations above historical trailing 1-year and 3-year trends. As speculators reduced their long British pound positions this week (12.8k long this week vs. 17.8k last week), long pound positions are now below extreme levels in the 3-year time frame (but remain in the 1-year time frame). Previous extremes continue in the US dollar, euro, and Canadian dollar.
The biggest change this week is in Japanese yen positions. In the previous week, speculators were short 88,971 futures and options contracts. This week, speculators are now short 104,837 contracts, an increase of 15,866. Given the yen’s safe haven qualities (the currency trades inversely to bond yields), investors bet on yen weakness as a proxy for a positive outlook. On the other hand, the Japanese yen tends to strengthen during times of economic peril.
Good times to keep rolling?
Looking at historical positioning in the yen, speculators have shorted the currency in anticipation of strong global growth and inflation or gone long the currency during slow global growth and low inflation. This can be seen below:
JPY correlates well with economic booms and busts
Speculators were short the yen for most of 2014 as global stock markets boomed. In 2015, yen short positions were trimmed significantly, and in 2016 yen investors went long the currency as both growth and inflation fell. Following Donald Trump’s victory in the US presidential elections, growth and inflation have powered ahead, and yen speculators have flipped to being net short again.
While yen speculators may be increasing their short positions as a result of recent political changes in Japan, our view is that domestic politics is likely to have a fairly limited impact on the currency. The more likely explanation is that speculators are making a bet on the global economic outlook. Thus the fact that speculators have increased their short positions suggests continued optimism in the future. As positions remain far from extremes (z-scores remain two standard deviations below their 1-year and 3-year trailing averages), it’s too early to suggest that sentiment is getting too crowded. If Trump can get tax reforms through Congress, the outlook for both growth and inflation will brighten considerably, helping the yen weaken from here. Yen speculators are counting on this happening.