The US Dollar recently hit fresh 2009 lows against the Euro and other key currencies, but several sentiment indicators suggest that the Greenback may be near a major bottom.
Recent CFTC Commitment of Traders data shows that large speculators are now extremely short the US Dollar against the Euro, Australian Dollar, New Zealand Dollar, Canadian Dollar, and Swiss Franc. The impressive and unusual confluence of sentiment extremes have put us on high alert. Moreover said extremes in CME futures likewise coincide with two other important FX indicators: Forex Options Risk Reversals and our proprietary Speculative Sentiment Index data.
According to Over-the-Counter Forex options markets, traders currently favor out-of-the-money (OTM) US Dollar puts by an impressive margin. In other words, most are willing to pay more for aggressive bets on USD weakness. We look at “Risk Reversals”—the difference paid for OTM Puts and Calls. Below we see relevant extremes in the EUR/USD exchange rate.
Euro/US Dollar 25-Delta Risk Reversals Versus Euro/US Dollar Exchange Rate
Finally, our proprietary Retail FX Sentiment Indicator shows an interesting divergence between crowd trading and
EUR/USD price action.
Those who read our weekly Forex Speculative Sentiment Index report know that we typically take a contrarian view of “crowd” positioning. In our experience, the majority of traders are quite often on the wrong side of the trade and we can view directional sentiment extremes as strong leading indicators. Recently we have seen that the majority of retail speculators have sold into Euro/US Dollar strength. Indeed, our most recent Forex SSI report accurately called for further US Dollar weakness into the current week of trading. Yet more recent SSI readings suggest there is tell-tale divergence between price and forex positioning.
Euro/US Dollar Speculative Sentiment Index Chart
In the chart above we see that the SSI ratio has actually moderated from recent extremes. Through last week the EUR/USD SSI ratio reached as low as -2.00—short positions in the EUR/USD outnumbered longs by 2 to 1. At that moment the pair traded at 1.3900 and traders seemed all-too-willing to sell into further rallies. Yet the most recent push above 1.4000 has meant that crowds are less willing to go short on EUR/USD strength. Though this is hardly an exact science, we believe that said divergence bolsters the case for a EUR/USD reversal and broader US Dollar rally.
Written by David Rodríguez, Quantitative Strategist for DailyFX.com