Positioning and Dollar Outlook Ahead of FOMC Meeting

Positioning and Dollar Outlook Ahead of FOMC Meeting

There is much data that will be reported in the week ahead.  The US reports consumer prices, retail sales and industrial output figures.  The eurozone reports industrial production and the final August CPI.  Germany’s ZEW will be released.  The UK reports consumer prices, the latest labor market readings and retail sales.  Japan reports industrial production and trade figures.  

However, the data is pale in comparison to the central bank meetings.  The focus is of course on the Federal Reserve, but the Bank of Japan and the Swiss National Bank also meet.  The general view in the market is that none of the central banks act.  Yet the risks abound.

The Swiss National Bank is the least likely to surprise.  Without much fanfare, the euro has steadily risen against the Swiss franc, and before the weekend reached its highest level (~CHF1.1050) since the franc’s cap was lifted back in January.  The SNB will say it is ready to act if needed, but there is no sense of urgency at the moment.  Moreover, the record paper losses the SNB reported in H1 14 is being pared this quarter.  The Swiss franc has depreciated about 3.5% against the dollar since the end of June and 5.2% against the euro.

There is only a slightly greater chance that the BOJ moves.  Most who expect additional monetary stimulus see it coming next month rather than now.  With deflationary forces not convincingly defeated, inflation far from the goal, and economic growth patchy, many think the BOJ has to step up its unorthodox monetary easing.  If boosting the monetary base by JPY80 trillion a year is not sufficient, will growing it by JPY90 trillion really do the trick, as member of parliament and an adviser to Abe suggested last week?

BOJ Governor Kuroda is still sounding relatively upbeat.  He seems to be playing down the official core measure of CPI (which excludes fresh food), and seems to be placing more emphasis on the measure that excludes food and energy.   After spending the last few months on his controversial political agenda, Abe appears to returning to economic issues, and fiscal support for the economy, which could include a supplemental budget as early as next month.  Pending fiscal stimulus also argues against more monetary easing.

The Federal Reserve is really center stage.  The issues have been debated ad nauseum.  The Fed had seemed to be edging toward a hike next week before the recent Chinese developments and the jump in capital market volatility.   Indeed the subsequent tightening of financial market conditions, and the slide in the US stock market, has been more associated with easing monetary policy, not tightening it.

What interests us here is the dollar’s technical condition ahead of the FOMC meeting.  Simply stated, that technical condition is soft.  After losing against all the major currencies except the Japanese yen last week, the dollar’s heavy tone looks set to carry over into the week ahead.

The US Dollar Index retraced 38.2% of the rally from the August 24 low (~92.62) to the September 3 high (~96.62) at the end of last week.  The RSI and MACDs are pointing lower and the five-day moving average is poised to fall below the 20-day average.  A break of 95.00 now warns of a move to 94.60 and possibly 94.15.

This is similar to the euro, which has the largest weight in the Dollar Index.  The euro actually finished last week above a similar retracement (38.2%), which came in a little above $1.1325.  The five-day average will likely cross above the 20-day average at the start of the new week.  The next immediate target is $1.1400, and then $1.1475.  A loss of the $1.1220-$1.1250 area signal a loss of the upside momentum.

The dollar is more clearly in a trading range against the yen.  Of note, the dollar has not closed above its 20-day moving average since August 18.  It is found now near JPY120.95.  A move above there needs to overcome the JPY121.30 area to be important.  A minor shelf has been carved near JPY120, but better support may be found near JPY119.60.

Sterling snapped a nine-day losing streak and rallied 1.7% last week.  It tested the 20-day moving average (~$1.5465).  It too has retraced a little more than 38.2% of the losses from the last August spike (~$1.5420) and the early September low (~$1.5165).  The next objective (50% retracement) is just above $1.5492.  The 50- and 100-day moving averages are around found in the $1.5515-$1.5525 range.   Soft inflation and retail sales data next week may be mitigated by an uptick in average weekly earnings and a generally healthy labor market report.  However, if the $1.5340 level goes, sterling may retest its recent lows.

The Australian dollar was the strongest of the major currencies last week.  It rose about 2.65% against the US dollar, and resurfaced above the monthly trend line that had been convincingly violated (~$0.7030 before slipped a little through $0.6900 at the start of last week).  It closed firmly and the technical indicators are favorable.  The 20-day moving average is near $0.7135, but there is potential toward $0.7170-$0.7200.

The Canadian dollar is not particularly interesting from a technical point of view.  The US dollar reached a multi-year high in late August (~CAD1.3555) and has moved sideways near its peak over the last couple of weeks.  This has neutralized the technical tools on which we rely.   The two current exogenous drivers are oil prices, which were net-net heavier last week, and the two-year interest rate differential, which saw the US premium narrow a couple basis points last week.  While this does not seem like much, according to Bloomberg it closed at its lowest level since late July (a little the than 24 bp).  Only a break of CAD1.3550 or CAD1.3120 would be noteworthy,

We would not expect 10-year US Treasuries to move much ahead of the outcome of the FOMC meeting.  Last week’s range of roughly 2.12%-2.25% will likely remain intact, barring a significant data surprise or a sharp increase in stock market volatility.

The November light sweet crude oil futures contract retraced 50% of its late-August through early-September run-up.  A break of the $44 could spur another quick dollar drop to the 61.8% retracement that is found just below $43.   The November contract has not closed below its 20-day moving average (~$44.25) since August 27.   On the upside, offers will likely come in around $47, the upper end of the recent range.

The technical condition of the S&P 500 looks encouraging.  The pre-weekend close was on the highs and the MACDs have turned higher.  However, it has failed to close above its 20-day moving average (~1979) since August 18.  Above there, re-establishing a foothold above 1985-2000 would encourage ideas that the correction is complete.  Initial support is seen near 1937.

II. Positioning in the Futures Market
The average daily turnover in the foreign exchange market is over $5 trillion a day.  Many traders and analysts put considerable weight on market positioning.  However, it proves very elusive.

What many institutions do is analyze their own flows.  I remember speaking to a central bank official about it several years ago. He said to me, if your flows are truly representative of “the market” it should show buyers and sellers of a currency offsetting each other, which will give me little information.  And if your flows are not representative, what use is it?

I worked at another bank that tried a different tack.  The analysts conceived of the market like a swarm of bees.  What they were interested in were the bees that led the swarm.  Rather than looking at where the buying and selling was coming from geographically, they organized their data flow by the execution style.  They found that those accounts that may call for immediacy often lead the market direction.

Such sophisticated studies are possible only at the very large banks, and typically the reports are not widely available.  Retail and some institutional participants often use the positioning in the futures market to get a sense of market positioning.  But here too, an open interest in the futures market of one contract consists of a short and a long position.  Hence the truism: for every long there is a short.

What interests us are not all positions.  The Commodity Futures Trading Commission requires (most) participants to declare whether they are a commercial, with underlying business interests, or a non-commercial, with no underlying business interest.  The non-commercial is understood to be a speculator.  Since their positions are seen as discretionary and directional (as opposed to hedging, for example), analysts monitor the speculative positioning.  The speculative positioning is understood to be a proxy for a segment of the market that are momentum trend followers.

There are many different ways that analysts have devised for looking at the speculative positioning.  Most focus on the difference between gross longs and gross shorts, which is the net position.  However, we have found that gross position changes are more revealing.  For example, a net speculative long position increases.  This could be the result of an increase in gross longs, or it could be a reduction in gross shorts.  We believe there is a fundamental difference between new buying and short-covering.

Here is the latest results of the speculative positioning in the currency futures:

After reviewing the historical record, we identified a 10k contract swing in gross position in the currency futures to be noteworthy.  In the CFTC reporting week ending September 8, there were two such significant position adjustments.  The first was a 14.2k jump (~10%) in the gross short euro position, bringing it to 157k contracts.  This is to say that speculators sold euros as it continued to give back the gains that had carried it above $1.17 on August 24.  These late shorts were in weak hands, and after the reporting period ended, the euro strengthened to $1.1350, suggesting some were likely shaken out.

The second significant position adjustment was a 13.8k contract reduction of short yen positions (~16.5%) leaving 69.8k contracts.   This is the continuation of a trend seen since early August.  In the reporting week ending August 11, speculators had a gross short yen position of 151k contracts.  The media and many analysts claimed the yen rallied because it is a safe haven.  A safe haven is thought to be a refuge during financial tensions that money can be parked in with less risk.  Yet the data suggests that the buying of yen was a modest part of the story.  The gross long position rose by 17.3k contracts since August 11.  The gross short position was cut by more than 80k contracts.

Some times there is a pattern that cuts across the currency futures that may offer insight into the general view of the dollar.  In the last reporting period, the gross short foreign currency futures were generally reduced.  The euro and sterling were the exceptions.  The adjustment of gross longs was more mixed, and minor in any event, as none changed by more than 5k contract.  Out of the seven currencies we track, four changed by less than 1k contracts.   This seems more consistent with a correction than a significant change in the underlying dollar bullishness.

Given the importance of the bonds and oil prices, we have applied a similar analysis to the speculative futures positioning there as well.  Speculators grew their net short 10-year US Treasury futures position.  This was accomplished by a 4.3k contract liquidation in the gross long position (leaving 407.8k contracts) and a 16.8k contract add to the gross short position (to 431.7k contracts). It is the second consecutive reporting period that the net speculative position was short.  This followed a six-week period in which the next position was long.

The speculative market has been net long light sweet crude oil futures since 2009.  In the latest reporting period the net short position grew by 11.1k contracts to 231.4k.  The bulls added 3k contracts to the gross long position, lifting it 490.1k contracts.  The bears covered 8.1k contracts, leaving 258.7k contracts still short.