Commitment of Traders Report and Technical Outlook

The latest Commitment of Traders report covers the week ending May 29.  Generally speaking non-commercial participants in the futures market were dollar buyers, either by adding to net short foreign currency positions, such as the euro and Australian dollar, or by reducing net long positions, as was the case in sterling and the Canadian dollar.   However, in the yen, Swiss franc and Mexican peso, the net short positions were reduced.  

Unlike most analyses of this weekly report, we find that drilling down into the gross speculative (non-commercial) positions sheds light on important shifts which just focusing on the net position misses.  Moreover, we think there is an important distinction between new buyers coming into the market and old shorts covering, yet the conventional interesting in the net position obscures.

Euro: The net short speculative position stands at a new record of 203.4k contracts in the week ending May 29.  The prior record from the previous week was 195.4k contracts.  Shorts rose by 13.6k contracts. Interestingly, the long positions also grew as bottom pickers came in and at 40.3k contracts, it is the largest gross long position in a month.  

The fundamental political and economic backdrop of the euro is poor.  As we began warning on May 29, there are increasing risks the ECB reduces rates to new record lows next week (and we noted that even prior to the dismal PMI and employment reports).  Meanwhile, redenomination risk has been raised, it cannot be easily addressed now until after the June 17 Greek elections. 

Yet it stands to reason, that some the of extended short positions may want to be reduced as the election draws near.  We need to stay attentive to technical signs such as reversal patterns or divergences.  Following the dismal US jobs data and heightened speculation that the Federal Reserve will announce QE3 when it meets a few days after the Greek election, the euro staged what may be a key reversal.  It recorded a new low for the move and than closed above the previous days high.

Follow through is needed and the London market, the largest foreign exchange center in the world, is closed until Wednesday, denying the market full liquidity.   Initial resistance is around $1.2500 and a move above $1.2620 could signal a deeper technical correction is at hand.  

Yen:  As global tensions rose and interest rate differentials narrowed, the net speculative short yen position was reduced to 11.3k contracts from 18.0k.  This net position is the smallest in three months.   Our argument that the yen's role as a safe haven is generally misunderstood is illustrated by the fact that the reduction in short positions did not happen because speculators bought the yen but because short were reduced.  The longs added 1.1k contracts.  The shorts were reduced by 5.5k contracts.  The yen's safe haven function has more to do with Japanese investors not exporting their savings more than foreign investors buying yen.  

While verbal intervention may continue, the risk of material intervention seems more modest than many market observers suggest.  What is happening is not so much a strong yen as it is weakness in other currencies.   Interest rate differentials have also narrowed and this reduces the opportunity cost of a home bias for Japanese savers.  A technical recovery in the euro may weigh on the yen as cross positions are reduced.  Initial support for the dollar is seen near JPY77.50 and then JPY77.00.  A move above JPY79 would help repair the technical damage. 

Sterling:  The net long sterling position was trimmed sharply to 1475 contracts from 11.3k in the prior reporting week.  It was a function of both longs exiting (-4.8k) and shorts being established (5k).   

Sterling has fallen about 6.3% against the dollar since April 30 and during that decline it has only closed the North American session higher on five occasions. Initial support now is seen near $1.5250 and resistance in the $1.5440-75 band.  If the euro does correct higher, sterling is likely to lag, suggesting that those trying to ride out a technical correction may find it more forgiving.  Also, after  a string of weak data, culminating in the very poor manufacturing PMI, the risk that the BOE resumes gilt purchases as early as this week's MPC meeting has risen.   Moreover, sterling does not have the large short position overhang the euro does.  

Swiss franc: The net short speculative franc position was trimmed by about 4.3k contracts to 30.6k.  This was a reflected both shorts being reduced and long growing in relatively equal amounts (2.3k and 2k respectively).  The SNB remains committed to defending its cap, even though the negative interest rates that are the result risks sparking undesirable distortions, like in the Swiss housing market.  

The franc, like the euro, recorded a potential key reversal on June 1.  Initial support for the dollar now is seen near CHF0.9600.  A break of CHF0.9550 warns that a deeper and longer correction may be at hand.  

Canadian dollar:  The net long speculative position of 34.1k contracts remains the largest long currency futures position, even though it was reduced by about 4.5k contracts.  It is also the smallest net long position since mid-April.  Stale longs were cut by 8.8k contracts.  Shorts may have grown impatient and cut positions by 4.3k contracts, and with the benefit of hindsight, the timing may have been poor as in the three sessions since the end of the Commitment of Traders report, the US dollar rallied about 2.3% against the Loonie.  

The US dollar surpassed the suggested target of CAD1.0420 and the next level of resistance is seen in the CAD1.0500-25 area.  The Bank of Canada meets on June 5.  It is not expected to do anything and the market has been pricing in rate hike by the end of the year.  We do not think this is likely, and given the pullback of commodity prices, especially energy, and the recent string of poor US data, the risk is of a more dovish or less hawkish slant.  Initial support for the US dollar is seen in the CAD1.0280-CAD1.0300 band.  

Australian dollar:  The net short speculative position more than doubled to 35.5k contracts.  This is the largest net short position since at least 1993.  To appreciate what a reversal this represents, note that at the start of May the speculative position was net long a record amount.  The decline in the net short position in the most recent week was more a function of longs capitulating (-15.2k contracts), more than short jumping aboard (+3.4k contracts).  

The Reserve Bank of Australia also meets on June 5.  While a 25 bp cut is widely expected, it is more likely to deliver another 50 bp cut than stand pat.  The Australian dollar staged a recovery after the poor US jobs data.  Additional upticks are likely to be capped in the $0.9750-75 range.  A move above there could signal gains toward $0.9900.  Meaningful support is difficult to find, though initial support may be around $0.9580-$0.9600.  

Mexican Peso:  The net short speculative peso position was shaved to 13k contracts from 16.1k.  This small move was mostly the establishment of new longs (+2.5k) while shorts were pared by about 600 contracts. 

Since early May, the US dollar has appreciated a whopping 13.6% against the peso.  The softening of the US economy, including slower May auto sales figures, does Mexico no favors.  The dollar reversed against the peso after the jobs data, peaking near MXN14.60.  It finished near MXN14.31 on June 1, a little below the previous day close.  The next level of support is seen around MXN14.07-MXN14.11.