WHY THE SHIFT IN USD POSITIONING IS VERY SIGNIFICANT
The price action in the currency and equity markets suggests that investor sentiment has improved. However considering the magnitude of the news that Citigroup plans to repay TARP funds, Abu Dhabi’s $10 billion support to Dubai World and Exxon Mobile’s $31 billion stock deal to acquire XTO Energy, we would have expected a more significant reaction in the financial markets. Instead, U.S. stocks ended the day virtually unchanged while the dollar gave back a small portion of its recent gains. The consolidation in the forex markets reflects the lack of U.S. economic data and hesitancy of currency traders to add to their long dollar positions ahead of the Federal Reserve’s monetary policy announcement on Wednesday.
Reining in Inflation Week
Based upon the latest labor market and consumer spending reports, there has been enough improvements in the U.S. economy to warrant a more hawkish stance from the Federal Reserve. However as recently as December 7th , comments Fed Chairman Ben Bernanke suggests he is not convinced that the improvements are here to stay. Although we are also skeptical about whether the U.S. economy has really taken a turn and question the possibility of positive job growth next month, at bare minimum, FOMC members will need to acknowledge the improvements. Their degree of hawkishness will also be partially contingent about the upcoming inflation numbers. It is inflation week across the globe with producer and consumer price figures due for release from many of the G20 nations. Tomorrow’s producer price report will provide an updated look at the latest inflationary conditions in the U.S. With import prices rising by the strongest amount in 5 months, inflationary pressures have accelerated and we expect this trend to be reflected in the upcoming PPI and CPI releases. Higher inflationary pressures should encourage more hawkish comments from the Fed but knowing that once they turn optimistic, they cannot pare back as readily they will try to stick to their cautious optimism as much as possible. How the Fed sways should determine how the dollar trades for the rest of the year.
Significance of Turn in Dollar Positioning
On Friday, the CFTC released their weekly Commitment of Traders Report, which measures positioning in the commodity markets. According to data from the Chicago Mercantile Exchange, future traders have reduced their short dollar positions across the board. In fact, speculative positioning in the EUR/USD turned net short for the first time since May. This shift from net short to net long dollars against euros is extremely significant. Since 2005, there has only been approximately 4 times (not including this time) that EUR/USD positioning has flipped to net short after being net long by more than 20k contracts. Each time, this shift in dollar positioning was a precursor to a more significant rally in the U.S. dollar. According to the following chart, the last time that speculative EUR/USD positioning (white line) flipped from net long to net short was in the first week of August 2008 and interestingly enough, that was the very week that the breakdown in the EUR/USD began, with the currency falling more than 3,000 pips or 20 percent over the next 3 months. W are certainly not saying that the EUR/USD will fall 20 percent from current levels because the move in the EUR/USD following each shift in dollar positioning has varied in terms of magnitude. However, the yellow vertical lines on the chart show that a flip consistently foreshadows a sell-off in the EUR/USD. If the Fed grows more hawkish on Wednesday, we could have a fundamental trigger for a more meaningful decline in the EUR/USD.
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