Speculative Positioning and Technical Outlook for FX

The major feature of the foreign exchange market in recent days has been the resilience of the foreign currencies, despite a stream of poor news.  As noted in last week's review of the Commitment of Traders, technical considerations struck us as more supportive for the major foreign currencies than the macro-economic backdrop.  

The latest Commitment of Traders report covers the week through April 24.  Given the further subsequent advance by the foreign currencies against the dollar in the spot market, we suspect that the next report will show the continuation of what is evident in this week's report.

The single most important take away from the new report is that for the first time since last August, the next speculative sterling position is long.  As has been seen in recent weeks, sterling's net short position has been trending lower as a combination of a reduction of short positions and an increase in long.

The speculative market is now net long 7.5k contracts.  Previously it was short 13k contracts.  Longs grew by 14.2k and at 47.4k stand at the highest level in nearly a year.   The shorts were pared by 6.4k contracts, though at about 39.9k contracts, which is a couple thousand higher than it finished last month.

An interesting technical development has been the turn of what some technicians call the "golden cross", the interplay of the 50- and 200-day moving averages.  They crossed to the upside for sterling on April 19th.  Sterling has posted a new leg up here in the second half of April.  It is now at multi-month highs.  For a technical perspective, there does not appear to be significant resistance before the $1.6450 area. 

The three-month implied euro volatility fell to its lowest level since mid-2008 at the end of last week (briefly below 9.5%).  Short-term speculative players need more volatility.  In lieu of it, both longs and shorts cannot be happy and thus moved to the sidelines.  Long positions were trimmed by 4k and shorts by almost 9k, for approximately a 5k reduction in the next short position to 113.3k.  

The euro remains in a clearly identifiable trading range.  $1.2970-$1.3000 marks the lower boundary and $1.3385-$1.3500 marks the upper boundary.  It is trading around the middle of this broad band.  A trend line drawn off the Feb 24 high and the early April high comes just above $1.3300 as the month draws to a close. 

We continue to advise medium term investors to reduce euro exposure as the euro nears the upper end of its trading range.  With polls showing the moderate Socialist Hollande beating Sarkozy in the second round and Greek elections resulting in a fragmented parliament, the risks seem to the downside, despite and, perhaps because of its resilience tone. 

The net short yen position was trimmed by about 2k contracts to 55.9k.  Longs were shaved by about 4k and shorts grew by about 6k.  The Japanese yen is easily the strongest major currency against the dollar this month with a 3.25% advance (in second place is the Canadian dollar up about ~1.9%).   

Ironically the yen's gains were extended after an extension of QE3 was announced.  While this was consistent with our views, many participants expected the yen to weaken.  We argue that monetary policy in general and QE in particular are only one factor that influences floating currency prices.   Many come to the conclusion that it is bad for a currency through deduction from economic principles, but an inductive exercise shows something else.

While there may be some psychological support for the dollar near JPY80, chart-based support might not come in until closer to JPY79.20.  The absence of full participation during the Golden Week holidays may remove more yen bids than offers, which would squeeze the still substantial short yen speculative positions.  

The Swiss franc is simply boring and that is just what the SNB seems to want.  The net speculative short position rose by about 2.5k contracts to 16.4.  Longs were trimmed by 1.7k contracts and the shorts added 1.1k.  The SNB seems content to have the euro trade in narrow ranges against the franc near the CHF1.20 cap.   Mild trend line support for the dollar comes in around CHF0.9050-CHF0.9080.

The net long Canadian dollar position rose by about 6.2k contracts and at 44.2k, it is the largest net long position since last May.  Longs rose by 4.7k to 63k, which is the largest since in a year.  Shorts fell by 1.5k contracts.   A break of CAD0.9780 area would seem, from a technical point of view, to open the door to CAD0.9500.  

The net long Australian dollar position was trimmed by 2.4k contracts in the week through April 24 to 46k.  Given the subsequent price action--the Australian dollar's sharp rally to 3 week highs after the soft Q1 CPI figures--the Commitment of Traders report may be downplaying the large long position that is being carried into the RBA's decision on May 1, where the only real question it would appear is 25 or 50 bp cut.  

Looking at the net position might also mislead.  Since peaking in late February, the gross long Australian dollar futures positions have been steadily reduced by 20% to just above 80k. 

The recovery in the Australian dollar is impressive and lifted the technical tone.  A move now above $1.0470 targets the $1.0570-$1.06 area.  

Mexican peso bulls have been trimming back positions in recent weeks and were caught wrong footed at the end of the week when the Mexican peso rose to its best level in three weeks on April 27 amid general dollar weakness and the decision by the central bank to keep rates steady (in the face of speculation of a rate cut).  

The longs were cut by 5.3k contract and at 58.5k is the smallest gross long position in more than a month.  Shorts were grew, but by less than 600 contracts.  The MXN12.92 area offers the next level of support and a break would signal little in the way of MXN12.80.