Looking at this week’s COT report, extremes continue in long crude oil and short Swiss franc positions. This is illustrated below:
CFTC COT (futures & options combined) – December 12, 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.
Looking at changes in positions this week, long gold positions are once again falling sharply. After declining by 55,142 net long positions last week, gold traders shed 73,481 futures & options contracts this week. While net positioning has not yet hit bearish extremes, this will become more likely if the current pace continues. We described how speculators have been historically outmaneuvered by the gold market last week.
Other notable changes include a build-up of long euro positions. As strong economic growth in the Eurozone continues, euro traders remain optimistic regarding the common currency. Speculators are also adding to Japanese yen positions as the probability of reflation becomes increasingly doubtful. As we wrote earlier in the week, inflation looks set to decelerate as the commodity rally runs out of steam.
Strong growth + weak inflation = euro bull market
Throughout the euro’s short history, the currency has strengthened when the global macroeconomic environment has been supportive. This is particularly the case when global GDP growth is accelerating and US inflation is weak. As weak inflation forces the Federal Reserve to adopt a more neutral policy, the euro is a big beneficiary from lower US rate hike expectations (which drives the dollar lower). While the prospect of accelerating inflation was looking more likely earlier in the year, flat or falling commodity price indices suggest a more neutral outlook going forward.
In terms of growth, recent figures from the US, Eurozone and Japan all suggest a continuation of accelerating GDP growth. While data from China and commodity producers (e.g. Australia) have been less hopeful, it’s still too early to call a global downturn.
Medium-term rally getting tired
While we believe the euro is likely to strengthen thanks to a supportive economic environment, the current bull market is nearing its end. 1-year and 3-year trailing z-scores are approaching bullish extremes, while technical indicators such as the RSI are not too far from overbought territory.
Earlier in August, both sentiment indicators suggested excessive euro bullishness. Looking at a chart of EUR/USD (below), the pair fell from above 1.20 down to around 1.16 by early November. This is shown below:
As euro dips in and out of bullish extremes, bull market nears end
As traders build their long euro positions once again, our sentiment indicators are likely to suggest an overbought market in the coming weeks. This time, the added risk is that the ongoing economic acceleration is more likely to slow down in 2018. While going long euros has been a fantastic trade for 2017, this isn’t likely to continue indefinitely. Our view is that the long euro trade will eventually run out of steam once global GDP growth begins decelerating.