Looking at the COT report for this week, short yen no longer looks like an extreme. Extremes in sentiment continue in crude oil and the Swiss franc. This is shown below:
CFTC COT (futures & options combined) – November 21, 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.
This week’s COT report contains a few noticeable changes in speculator positioning relative to recent history. Firstly, yen positions have grown this week as speculators debate the outlook for inflation. Previously, shorting the yen was a consensus favorite with speculators increasing their short positions week after week. Secondly, the US dollar is again out of vogue, with both the US dollar index and our implied US dollar positioning indicator showing decreasing USD positions. Previous reports showed increasing US dollar long positions. Lastly, commodity currencies (AUD and CAD) remain out of favor. This trend continues from previous weeks as concerns grow regarding commodity over-supply and slowing growth in China.
Speculators hedge the USD comeback story
In last week’s take on the COT report, we showed that our implied positioning indicator for the US dollar had finally become positive. The last time speculators were net long the US dollar was in early July. Following Trump’s inability to deliver on healthcare reforms, markets began to doubt the outlook for inflation and more rate hikes. After a significant sell-off in the US dollar, speculators went net short the currency in late summer. As net positions in USD hit bearish extremes in October, our view was that the currency was due for a small bounce. While the dollar has strengthened from its earlier lows, a larger upside move still looks out of reach. An overview of net positioning in the US dollar versus 1-year z-scores are shown below:
Now what? Net short positions fall from extremes
Outlook remains neutral, but many catalysts for a longer-term rally
In the longer-term, factors such as tax cuts, accelerating commodity prices (crude oil in particular) and healthcare reforms could ignite a dollar rally. As US GDP growth remains strong, rising inflation can spark future rate hike expectations. As inflation has been falling since the first quarter of this year, markets have been doubting the Federal Reserve’s resolve in 2018 and beyond. If Trump can get tax cuts through Congress, inflation expectations could rise materially.
This week’s decrease in USD and increase in JPY net positions suggests that markets continue to debate the direction of inflation. Despite the ongoing crude oil rally (a reliable front-runner of inflation) and the potential for US tax cuts, net positioning remains neutral.