CoT Analysis: Smart Money Sets the Stage for a Higher US Dollar
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The CoT report, against conventional belief, does not represent a lagging indicator. The right interpretation of the data provided, published every Friday at 3:30 E.T., and reflecting the commitments of traders up to the prior Tuesday, offers comprehensive insights to gauge how the smart money is positioned. Large institutions and commercials tend to leave a trail of breadcrumbs along the way, and through the CoT, we can follow what their intentions are, therefore, it should be seen as a valuable resource.
In the following article, based on the Commitment of Traders report, I will expose how the unpacking of last week’s change in futures and options positioning reveals a fairly benign picture for the interest of those looking to stay long the US Dollar in coming weeks/months, barring any major unforeseen shocker. The latest CoT data exhibits that the overall market positioning is constructive and supports the narrative of a continuation in the DXY (US Dollar Index) bullish trend against ‘risk on’ currencies. I come to this conclusion after the major increases in open interest across FX majors such as the Euro, Sterling, Aussie, matching the directional moves seen in rates. Besides, the death cross in our prop risk-weighted index (chart below) is further evidence that we are entering an environment that should be dominated by ‘risk-off’ flows set to benefit the USD.
Main Takeaways from the Euro Contract ((6E – CME))
The latest reading provided by the CME indicates total outstanding positions at 627,884 vs 574,970, the highest increase in open interest since late May, and it communicates that the breakout of the 1.15-1.18 range came amid a much stronger commitment to the short-side business.
Therefore, a continuation of the dominant bearish trend is expected, barring any major turnaround in sentiment should the US and China strike a trade deal. However, with additional tariffs on Chinese and US goods set to stay in effect until the higher-stakes summit between the US and China’s Presidents in Nov, it allows room for the decline to stay its course.
Total specs shorts increased by over 15k, taking the total net outstanding positions into negative territory for the first time since May ‘17. There is plenty of room for specs to add into their shorts and provide fuel to the trend due to the under stretched nature of their positioning. Large specs are often referred to as the smart money, historically providing a high accuracy rate in getting the direction of the underlying trend right.
Commercials bought Euros aggressively as one would expect given the elongated move. Total longs increased by 8% according to the CFTC data. The need by commercial accounts (hedgers) to buy the underlying contract increased in order to minimize the risk of exchange rate variations in the future. It was a compelling opportunity given the major decline in the EUR/USD rate.
Asset managers pulled the rug under the Euro and no longer appear to be adding to their perma long view, as last week’s slide revealed their total outstanding positioning at 147,500 vs 153,744, with the reduction led by renewed selling interest. This development adds to the overall bearish narrative in the 6E contract and as a result, in the bullish view for the USD.
Main Takeaways from the Sterling Contract ((6B – CME))
The Contract sees the most aggressive increase in open interest this year, which coupled with the unambiguously bearish move in the Sterling market, makes the perfect case for a bearish continuation going forward. The absence of clear horizontal levels of support as reference until 1.26 provides an area with limited liquidity, which adds to the bearish view.
When breaking down the long vs short specs, it unpacks a rather interesting picture, as the overall positioning only added an extra -3k total spec short due to the ample rise in new long and short-side business, to the tune of almost 14 and 18k new contracts respectively. It means that there was some significantly high interest by the specs community to be buyers too.
As expected, commercial longs felt compelled to add into their current longs, increasing the total net exposure by almost 10k to 83.5k. These account-types are far from extreme levels, with the weekly changes not providing the slightest hint of a turnaround in fortunes for the Sterling.
As in the case of the Euro, and probably triggered by the technical milestone achieved in the DXY, where a major weekly resistance was finally cracked, asset managers turned more bearish, increasing their sell-side bets from -40.8k to -43.8k.
Main Takeaways from the Japanese Yen Contract ((6J – CME))
Open interest was barely changed, it stood at 214.1k from 214.9k. If one throws into the mix the inconclusive price action dynamics within a 100 pips compressed range, this week’s open interest fails to provide new clues worth taking note.
Looking into the large specs community, the data reveals that we had a mild renewal of long-side buy interest towards the Yen, with the total net positioning reduced by over 4k due to an actual rise in the long contracts opened in the Japanese currency. A bullish input for the JPY.
Yen commercial longs, interestingly, lightened up their positions despite they had an opportunity to add on the ephemeral rise we saw from 110.00 through 111.00. Commercials not adding is a clue that they might be expecting lower levels before piling in new longs (higher USD/JPY).
Asset managers tracked the dynamics seen in the large specs accounts by increasing their Yen longs within the contained range seen, which is evidence of the tentative signs of an increasing selling pressure keeping the USD/JPY prices limited to the upside.
Main Takeaways from the Australian Dollar Contract ((6A – CME))
The total open interest was boosted by over 14k, the highest increase since May. The increase in the number of outstanding positions was accompanied by sharp losses in the Aussie, which implies a bearish backdrop going forward and solid chances of a downtrend resumption.
Total large specs increased their short bets but not by as much as one would expect. The total net positioning stands at -55.1k vs -53.7. Lev funds short the Aussie saw a slightly higher short-side commitment after an increase of over 3k new contracts.
Total commercials remain one of the most revealing snippets of data when analyzing the Aussie. Positions remain near extremes, although they eased a bit last week given the major increase in open interest, which takes the % commercials vs open interest to 46% from 49%, with total longs increasing by just 2k, which is a fairly poor number considering the sharp move in the Aussie.It means that while commercials readings are near extremes, the weekly change is far from communicating evidence of a potential reversal with enough substance behind.
Risk-weighted index: Death cross (50 & 100 SMA)
Additionally to the analysis conducted above, the chart below (3-day performance) illustrates that the overall risk environment is far from the positive conditions experienced back in 2017, where a stage 2 risk trend was in play. We have now entered a topping phase in risk, which more often than not entails support towards safe haven the likes of the Japanese Yen, Swiss Franc and the US Dollar.
How to be Positioned Goign Forward
In light of the analysis provided above, investors and/or traders should remain overall bullish the US Dollar, with the current corrective leg likely to be limited in time and extension before the resumption of the buy-flow imbalances in favor of the USD. The Euro, the Aussie, and especially the Sterling, are all set to continue its respective underlying downward trajectory. In the Euro/US Dollar, the increased supply pressure from last week suggests that any approach towards 1.1550 and 1.16 presents a great opportunity to reinstate shorts; this scenario will only be negated upon a price consolidation above the 1.1650. In the case of the British Pound, the outlook is even worse, with no end in sight to the bearish trend for the time being; levels to engage are largely dependable of your trading profile, although the side to remain most at risk is unequivocally the downside. As per the Aussie Dollar, expect the range 0.73-0.74 to cap the recovery; it would take a rise and hold above the latter to negate the bearish picture.
Important Footnotes:
Volume & OI: Open interest represents the total number of contracts, including both buy and sell positions, outstanding between all market participants. We should think of open interest as new business (additional liquidity). Open interest is closely linked to liquidity. Generally, to gain conviction over a potentially developing bullish market, we could analyze whether or not open interest increases, new buyers coming in, which fuels the continuation higher on renewed commitment, ideally replicated by volume increasing or at least maintaining a steady measure. If on a bullish market, the open interest is decreasing, it has a different meaning all together, suggesting shorts covering, players stopped out, and hence money is leaving the market. This information to understand move dynamics is key.
Large Specs: The Net Non-Commercial Positions, often referred as Large Specs, comprise contracts held by large speculators, mainly hedge funds and banks trading currency futures for speculation purposes. Speculators, for the most part, have no need to use the futures market as hedging, with the sole intention being speculative in nature, buy or sell at a profit, before the contract becomes due. This category tends to carry large positions and are often guided by fundamental developments. Historically, they are characterized by being trend-followers and tend to get the right directional bias.
Commercials: Entities that are commercially engaged in business activities hedged by the use of the futures or option markets. The main characteristic of this group is that their activity orbits around the need to buy or sell the underlying contract to minimize the risk of exchange rate variations in the future. Like the large specs, this group also tends to carry large positions at times and due to the hedging nature of its activity, act as contrarian traders, best buying when prices are low and vice versa.
Dealers: These participants are typically described as the “sell side” of the market or net hedgers. They don’t take positions to speculate for profits, but instead design various financial strategies to allocate assets to institutional clients. They help us understand supply and demand dynamics and act as liquidity providers and tend to have matched books or offset their risk across markets and clients. Futures contracts are part of the pricing and balancing of risk associated with the products they sell and their activities. These include large banks (U.S. and non-U.S.) and dealers in securities, swaps and other derivatives. These participants track very closely the open interest.
Asset Managers: These are institutional investors who tend to act slowly in established trends, which include pension funds, endowments, academic institutions, insurance companies, mutual funds and those portfolio/investment managers who predominantly represent institutional clients. Their performance is based on the average of the industry, not in the business of taking contrarian positions and/or changing their macro view that often.
Leveraged Funds: These are typically hedge funds and various types of money managers, including registered commodity trading advisors (CTAs); registered commodity pool operators (CPOs) or unregistered funds identified by CFTC. The strategies may involve taking outright positions or arbitrage within and across markets. The traders may be engaged in managing and conducting proprietary futures trading and trading on behalf of speculative clients.
