US Dollar May Have Set Important Bottom versus Euro

Forex Options and Futures markets show US Dollar sentiment at major bearish extremes versus the Euro, Swiss Franc, and Canadian Dollar. Such one-sided sentiment strongly suggests that the US Dollar could soon recover from its recently sizeable losses, and indeed we believe that the downtrodden Greenback could finally recover on a broad basis.

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Volatility expectations themselves have remained fairly limited despite pronounced US Dollar weakness. This in itself suggests that the recent pace of dollar losses may not be sustained. More importantly, we are beginning to see signs that pairs such as the EURUSD reverse from their previously impressive trends. It clearly remains critical to watch price action in the weeks ahead. Sentiment can and does remain extreme for extended periods of time, but the confluence of bearish USD positioning suggests that the Greenback could soon turn against key counterparts.

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Futures positioning shows that Non-Commercial traders (typically large speculators) have become extremely net-long the Euro against the US Dollar. In fact, said speculative positioning is the most long EURUSD since it traded near 1.6000 in early 2008. We consistently warn that extreme positioning and sentiment can and does remain extreme for extended periods of time. Yet it is interesting to point out that options sentiment actually shows many traders are beginning to hedge against EURUSD weakness. It’s possible that the EURUSD has set a noteworthy medium-term top.

Futures and options sentiment points to further losses for the British Pound, as markets have aggressively sold the currency through recent trade. Net Non-Commercial positioning dropped precipitously as the GBPUSD broke below the psychologically significant 1.6000. Yet current positioning is a good distance from major sentiment extremes. In other words, there is still a good deal of margin for further selling, and we cannot confidently call for any worthwhile GBPUSD corrections through upcoming trade. FX Options show that traders are indeed hedging against further GBP weakness.

Impressive Japanese Yen rallies (USDJPY declines) have led to similarly impressive positioning in futures markets, with Non-Commercial traders the most heavily net-short USDJPY since it last traded below 90. The key difference this time around is that forex options market sentiment is far less extreme. This gives the sense that the Yen has further room to run, and a challenge of generational lows near 87 seems plausible.

Traders have grown extremely net-long the Canadian dollar (short the USDCAD) through recent trade, with FX Futures data showing sentiment at its most bullish since the pair traded near parity. Forex options markets likewise show that traders are increasingly betting on USDCAD weakness—emphasizing that sentiment remains extremely bearish. Given such headwinds, we believe that the USDCAD downtrend is near its end. The recent rebound in options sentiment shows that some are beginning to hedge against CAD weakness (USDCAD strength).

Non-Commercial futures positioning on the US Dollar/Swiss Franc pair remains the most bearish in nearly 5 years—pointing to clear sentiment extremes. Swiss Franc long positions (USDCHF shorts) outnumber short positions by a whopping 23,791, and it is little surprise to note that the USDCHF trades very near parity. Yet the last time net-long CHF positions grew to this level was in December, 2004. At that point the USDCHF set an important low and rallied over 1000 pips in 10 months. Past performance is not a guarantee of future results, but the likelihood of a USDCHF bottom is high.

We continue to call for a sustained Australian dollar pullback, as sentiment has remained extreme for quite some time now. Non-commercial futures traders remain the most net-long the AUDUSD since the pair traded above 0.90, but the timing of said retracement remains extremely challenging. Forex options market sentiment previously hit major extremes and has since moderated. Our earlier calls for AUDUSD pullbacks were clearly premature and highlight the difficulty in timing trades on sentiment extremes. Yet we remain bearish the AUDUSD.

The New Zealand dollar/US Dollar pair is quite similar to the AUDUSD, with significant sentiment extremes leaving the door open for near-term declines. As of last week, Net Non-Commercial positioning on NZDUSD futures remained the most net-long since the pair set noteworthy tops in July, 2007.

Written by David Rodríguez, Quantitative Strategist for DailyFX.com, [email protected]