Forex options markets suggest that the US Dollar may continue to rally against the Euro, British Pound, Australian Dollar and New Zealand dollar. Yet an overall downtrend in forex market volatility expectations warns that key currency pairs could remain stuck in medium-term trading ranges. It will be critical to watch for signs of breakout in major US Dollar exchange rates.
We will need to keep a close eye on forex options market-derived volatility expectations.
Forex options markets suggest that the US Dollar may continue to rally against the Euro, British Pound, Australian Dollar and New Zealand dollar. Yet an overall downtrend in forex market volatility expectations warns that key currency pairs could remain stuck in medium-term trading ranges. It will be critical to watch for signs of breakout in major US Dollar exchange rates, and we will need to keep a close eye on forex options market-derived volatility expectations.
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Our DailyFX Volatility Indices emphasize that trend expectations remain low. Indeed, recent forex market price action has left pairs such as the EURUSD and USDJPY in relatively narrow trading ranges. Absent a noteworthy shift in volatility expectations, it will be difficult to call for a sizeable US Dollar breakout versus major trading counterparts.
Euro/US Dollar Options Analysis
The Euro/US Dollar recently hit a powerful bullish extreme on its run up to year-to-date highs, and we have consistently favored EURUSD declines through the past several weeks of trade. The fact that COT net Non-Commercial longs recently eased off of extremes adds weight to the argument, and we likewise note that both 1-week and 3-month Risk Reversals are considerably off of their highs. Though we may need to wait for a significant bounce in volatility expectations to call for a Euro breakdown, our options sentiment-based EURUSD forecast remains bearish.
British Pound/US Dollar Options Analysis
Forex Options-based outlook for the British Pound/US Dollar pair remains similarly bearish, and a major sentiment extreme threatens to derail GBP strength. In fact, recent CFTC Commitment of Traders data showed that traders hit their most net-bullish levels since the GBPUSD traded near 2.00. We remain bearish on sentiment extremes, and the downturn in risk reversals suggests that options traders are gearing up for GBPUSD weakness. The one caveat remains low volatility expectations: absent a noteworthy bounce in volatility, the GBPUSD may remain range-bound.
US Dollar/Japanese Yen Options Analysis
FX Options markets risk reversals recently hit bullish extremes on the USDJPY, but it is interesting to note that said extremes did not coincide with similar developments in Non-Commercial Net Positions. In fact, COT data shows that speculators are just barely bullish the USDJPY with Net Non-Commercial Positions at the middle of their multi-month range. The USDJPY remains stuck in a fairly wide trading channel, and relatively mixed trader sentiment gives few clues on short-to-medium-term direction.
US Dollar/Canadian Dollar Options Analysis
The US Dollar/Canadian Dollar pair recently reversed sharply on clear sentiment extremes, and the resulting rally is a classic example of what can happen when currencies reverse on one-sided positioning. Indeed, Commitment of Traders data showed that Non-Commercial traders—typically speculators—were the most net-short the USDCAD since it traded near parity. The COT extremes coincided with similarly overextended FX Options risk reversals, and the result was clear. Near-term implications are far less straightforward, and near-neutral FX Options give little indication on what to expect.
US Dollar/Swiss Franc Options Analysis
Commitment of Traders data shows that speculators remain the most net-short USDCHF since it traded near parity, and apparent sentiment extremes suggest a near-term rebound is likely. Forex options market risk reversals hit their most USDCHF-bearish levels through the end of May, and a recent bounce shows that traders have geared up for a US dollar bounce. Yet it remains important to point out exceedingly low volatility expectations. Absent a sharp shift in implied volatility levels, the USDCHF could remain in its 1.0600-1.1000 range.
Australian Dollar/US Dollar Options Analysis
Australian dollar positioning and sentiment remains quite bullish, and one-sided COT data suggests that the AUDUSD pair could turn lower through upcoming trade. Indeed, Non-Commercial traders remain the most net-long AUDUSD since late 2008, and FX Options market risk reversals have registered roughly comparable extremes. There remains clear risk that the AUDUSD will turn lower, but it will be critical to watch near-term volatility expectations across US Dollar pairs.
New Zealand Dollar/US Dollar Options Analysis
The New Zealand dollar/US Dollar pair is quite similar to the AUDUSD, with Non-Commercial COT positioning at major bullish extremes. In fact, net Non-Commercial positions are at their most bullish since the NZD peaked in July, 2007. One-sided sentiment clearly leaves risks for a material turnaround, and it will be critical to watch for early signs of potential reversal in the high-flying pair.
Written by David Rodríguez, Quantitative Strategist for DailyFX.com, [email protected]