Looking at this week’s COT report, extremes include the Swiss franc, crude oil and a new bearish extreme in the Japanese yen. This is shown below:
CFTC COT (futures & options combined) – November 14, 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.
The last three weeks have seen a similar set of themes emerge from the COT report. Firstly, speculators continue to bet on accelerating inflation by shorting currencies with negative rates and dovish central banks. Based on the analysis above, warning signs are flashing for both the Swiss franc and the yen. Secondly, commodity currencies have fallen out of favor, with ongoing declines in net positions for the Australian dollar and the Canadian dollar. Lastly, crude oil net positions are looking more stretched, with 3-year trailing z-scores more than two and a half standard deviations above historical averages.
As crude soars and hopes for US tax cuts increase, short yen becomes the crowd favorite
Based on recent history, the last time yen positioning was extreme was back in early 2016. At the time, net positions were at a bullish extreme. 3-year z-scores were almost four standard deviations above the historical average in January. While remaining at a bullish extreme, the yen strengthened throughout the first and second quarter of 2016. The currency formed a long-term top in the third quarter and weakened significantly following the victory of Donald Trump in the US elections. This is highlighted below:
Consensus caught the big move the last time. What about this time?
Today the consensus is once again at an extreme, and this time speculators are short the currency. Thanks to soaring commodity prices and hopes for US tax cuts, the outlook for inflation is looking brighter. While inflation has been decelerating for most of this year, this trend is likely to change in the near future. Similar to the fourth quarter of 2016, the yen is likely to weaken significantly if both economic growth and inflation accelerate in tandem.
In an earlier commentary, we explained how USD/JPY could rise above 115 thanks to strong growth and inflation. While the yen becoming a consensus favorite doesn’t help our view (because large and one-sided speculator positions are vulnerable), we continue to believe that the yen can keep weakening from here. Of course, this comes with the caveat that shorting the yen is now a crowd favorite and at the risk of a significant reversal.