Currency Positioning and Outlook

Market positioning in the week ending August 7 suggests that speculators in the futures market generally agree with our assessment that ECB President Draghi's recent proposal was not a game changer.  The recent pattern continued.  Essentially what this entails is buying the Australian and Canadian dollars and Mexican peso and some light position adjusting in the other currency futures--euro, yen, sterling and the Swiss franc.

Although many observers see the strength of the dollar-bloc currencies and peso, but also the Scandi currencies and the Polish zloty, for example, and conclude that the speculative operators are selling the euro on the crosses.  However, the Commitment of Traders report does not bear this out.

Euro:  Gross long euro futures positions rose for the third consecutive week.  The 5.4k increase brought the gross long position to 46.7k.  Gross short positions fell for the fourth consecutive week.  The a little less than 2k shorts were covered, still leaving a large gross short position of 178.5k contracts.  This combination produced a modest decline in the net short position from 139k to 131.7k contracts, which is the smallest in almost three months.  

Yen:  The net long yen position was trimmed to 27.5k contracts from 32.3k.  Yet this did not reflect decline in gross longs.  They actually edged higher by a little more than 500 contracts to 55.9k.  The decline in the net long position was a function of 5.2k new shorts coming being established.  

Sterling:  At a net short 8.3k contracts, the speculative position, though quite modest, is the largest in over a month.  The gross shorts rose by almost 1k contracts.  It was the 5.5k decline in gross longs that accounts for the bulk of the change in the net position.

Swiss franc:  Like the other currency major currency futures, the change in speculative positioning in the franc was quite modest.  The net short position fell by less than 1k contracts to 17.9k.  The gross long position rose by 1.4k contracts, while the gross short position rose by a little less than 500 contracts.  

Canadian dollar:  The net long speculative position rose to 19.1k from 12.4k contracts.  It is the largest in two months.  The  bulls continue to accumulate.  They added 12.5k contracts to 43.2k.   Some speculators tried, unsuccessfully, to pick a top in the Canadian dollar and added 5.9k shorts to 24.1k contracts.  

Australian dollar:  Speculators like the Canadian dollar, but they like the Australian dollar even more. The net long position jumped to 52.9k contracts in the week ending August 7 from 37.2k the previous reporting period.  It is the largest in three months.  Longs added 14.8k contracts to 94.6k.  Some bears capitulated and covered about 920 contracts, but still hold 41.7k contracts.  

Mexican peso:  Ok, so futures speculators like the dollar-bloc.  You get that.  But they like the Mexican peso even more.  The gross long position rose to 69.4k from 47.6k contracts.  This is the largest in four months.  The bulls bought another 12.4k contracts and now hold 81.9k.  The bears covered almost half their shorts (9.4k) to hold 12.5k contracts.  

II

The price action in recent days have not been conclusive.  Last week we had anticipated some follow though buying of the European currencies by around the middle of the week.  This failed to materialize.  In fact, the euro and Swiss franc recorded their lows for the week on Friday.  Yet, sterling made its highs for the week on Friday, and the euro and Swiss franc did not violate key support areas.  

A potential trend line drawn of the euro's multi-year low recorded on July 24 near $1.2045 and off the post-Draghi low near $1.2135 comes in now near $1.2220.  In addition, the  key retracement of the euro's gains on what many regard as the reevaluation of Draghi's comments was violated intraday on Friday with a break of $1.2250, but the euro still managed to close above it.  

This sense of inconclusiveness is also evident in the Dollar Index.  It help key support near 82.00 area  early in the week, but it also held below the 82.95 resistance at the end of the week.   Similarly, the dollar's recovery stop shy of trend line resistance against the Swiss franc, which comes in near CHF0.9825 on Monday and declines by about 12 ticks a day, finishing next week near CHF0.9785.  

Technically, the yen and sterling are uninspiring.  They remain well within recent ranges against the dollar.  There is no compelling sign that would allow us to anticipate a near-term break out.  With minor exceptions, the dollar has been confined to a JPY78 handle since mid-July.  

For its part, sterling has been confined to a $1.54-$1.58 trading range since early June.  Although on Friday, sterling finished the North American session at its highest level in August, it is difficult to get excited.  We are more inclined to sell into additional strength, expecting the trading range to remain intact.   Moreover, the week ahead sees a number of UK economic reports and on balance they will underscore expectations for continued QE even after the current gilt purchase program is completed.  

Last week, we had thought the Australian and Canadian dollars were looking a bit toppish.  We were wrong and both currencies continued to advance.  Indeed the price action on Friday was particularly constructive for both.  They both recovered smartly after from initial losses and managed to finish the week near their best levels.  Technical factors favor addition strength.  

The Reserve Bank of Australia recognized that the Aussie's strength crimps growth, but few participants expect material intervention.  Moreover, the market has understood the RBA's economic assessment to signal it is in no hurry to cut interest rates.  In a world of low interest rates, Australia is an attractive place to park funds as is Canada.  

The implied 3-month Australian dollar volatility slipped to its lowest level since 2008 on Friday before recovering.  If the Australian dollar punches through the $1.06 area on a convincing and closing basis, implied volatility is likely to rise as it would raise expectations for a move toward $1.08-$1.0850, levels not seen in five months.   

The US dollar broke below CAD1.000 and, although it found support a big figure lower.  There does not appear to technical reasons not to look for continued greenback weakness.  Moreover, the Bank of Canada has not tempered its hawkish bias, despite speculation that the Federal Reserve is preparing for move stimulus.  The next important chart point is near CAD0.9800.  

Not only does Mexico offer even higher rates than Australia, which attracts flows, but the Mexican stock market is one of the stronger equity markets.  The Bolsa is up a little more than 10% thus far this year, while the Toronto Stock Exchange is off 0.5% and, by comparison, the Australian stock market is up almost 5.5%.  In addition, the implied volatility of the peso has also eased and this may also underscore its appeal on a risk-adjusted basis.  While the MXN13.00 area offers psychological support for the dollar, the technical target is the early May lows near MXN12.88.  

III

France and Germany will report Q2 GDP on August 14 as will the euro area.  Germany's ZEW survey will also be released that day.  Yet, the economics seem secondary to the politics.  And the politics will not be resolved in the days ahead.  Instead, European officials will send the next couple of weeks on vacation and staking out positions, ahead of September's key decisions.  

Perhaps it is like a multiple choice exam.  Students are often instructed that their first answer is often the best  The market initially was skeptical the merit of Draghi's proposals and then apparently reconsidered.  In part this was due to Draghi giving the impression to a similarly inclined market that Bundesbank's Weidmann was isolated.  

However, subsequent reports suggest there was not a formal vote and Weidmann may not be as isolated as Draghi would have us believe.  Look at Belgian central banker Coene's comments.  He said that ECB purchases of Spanish and Italian bonds won't solve their difficulties or restore investor confidence.  The conclusion, he drew from last year's ECB purchases of Italian bonds and PM Berlusconi reneged commitment, is that "when you take away the market pressures, you take away the pressure on politicians to act."

If at first the market responded by the lack of ECB action, and then focused on the implication of Draghi's proposal to buy short-term bonds, perhaps it will now come over to our view and focus on the conditions Draghi imposed on the resumption of ECB bond buying.  

Countries would have to formally request aid, sign a memorandum of understanding, which if nothing else will likely requires the gravitas and sovereignty eroding quarterly visits by the official creditors represented by the Troika.  In addition,  an disbursement of aid will require unanimous agreement by the member countries.  For some it may be an executive decision.  In others, like Germany, it will require parliamentary (or a committee thereof) approval.  

In addition to euro area developments, the other main consideration is the state of the US economy.  The economic data in the coming days, especially the July retail sales, industrial production and the August Philly and Empire State Fed surveys, will likely show that there has been no further slowing of the US economy.  

While these reports may be helpful, the key is understood to be the August jobs report (September 7).  The four week moving average of weekly initial jobless claims has been trending gently lower since the July national survey was conducted and our preliminary guesstimate is the economy is generating roughly the same number of net jobs as it did in July. 

Nevertheless, the economic data to be released in the coming days do not have the impact Fed expectations.  These expectations may partly turn on one's perception of the FOMC's bias:  Does the economy have to deteriorate further for the Fed to act or is it the case that the economy (labor market) must show improvement otherwise the Fed will move?