In this week’s eventful COT report, there are new extremes in long British pound and short Australian dollar positions. Short Swiss franc net positions are no longer at an extreme, while long crude oil remains a consensus long position in the speculator community. This is shown below:
CFTC COT (futures & options combined) – December 19, 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 biggest changes in net positions this week include rising British pound positions and falling Australian dollar, euro and Swiss franc positions. Long British pounds is now two standard deviations higher than its 3-year trailing average as speculators believe more Brexit negotiation breakthroughs are likely. We have argued in the past that markets are overly optimistic regarding Brexit in the medium-term, especially given the EU’s offer of a “Canada-style” trade deal.
Speculator interest in buying euros is now falling, as EUR/USD has been trading in a narrow channel between 1.17 and 1.19 for the past four weeks. Last week, long euro positions were fairly close to extremes. Lastly, speculators are also taking profits on short Swiss franc positions, as EUR/CHF trades above 1.17 for the first time since the Swiss National Bank broke the peg in 2015.
Elevated net positions drive AUD trading
Looking at Australian dollar net positions in recent history, speculators have mostly been long the currency since February 2016. Given Australia’s reliance on Chinese commodity exports, the currency has been strengthening alongside the rising fortunes of the Chinese economy since early 2016. This is shown below:
Bullish extremes foreshadow sell-offs in the Australian dollar
Bullish net positions were at extremes in late April 2016 (3-year z-score = 2.5x) and again in late September 2017 (3-year z-score = 2.1x). In both cases, the Australian dollar weakened sharply after long positions became too crowded. Looking at AUD/USD, the pair fell from above 0.77 in late April 2017 down to 0.71 by late May. After trading near 0.79 in late September 2017, AUD/USD is currently around 0.77.
Australian dollar has more room to fall
Since early December, when AUD/USD bottomed around 0.75, the Australian dollar has been rebounding. After this week’s Commitments of Traders report, which shows short positions in the currency at negative extremes (1-year z-score = -2.0x), it is tempting to go long Australian dollars today. While the currency has room to strengthen in the short-term, our long-term outlook on the Australian dollar remains bearish for a few reasons.
Firstly, the Australian dollar is highly sensitive to news from China, and our outlook on Chinese growth remains bearish. In rate of change terms, the Chinese economy has been slowing thanks to lower credit growth started in the last quarter of 2017. Empirically, this can be seen from slowing new house prices as per National Bureau of Statistics data. Secondly, expectations for rate hikes are unlikely to materialize in 2018 as both GDP growth and inflation remain weak. Q3 2017 GDP growth missed expectations, while our outlook for global inflation is also bearish. Lastly, we foresee long-term weakness in most commodities, especially as long crude oil speculator positions remain in extremes. As a commodity-exporting country, the Australian dollar will ultimately weaken once commodity prices fall next year.
All in all, speculators have been late to the game when trading the Australian dollar. Traders bought the currency near its peaks and are selling AUD after its recent move down. While the current counter-trend strengthening episode may last a few more weeks, we foresee weakness in the Australian dollar in 2018 and beyond.