US Dollar Poised for Declines on Trader Sentiment Extremes

From DailyFX

Forex futures and options positioning suggests that the US Dollar (ticker: USDOLLAR) could soon post important losses against the Euro, Australian Dollar, Canadian Dollar, and Swiss Franc.

CFTC Commitment of Traders data shows that speculative futures traders are their most net-long the US Dollar against the Euro on record. And though sentiment extremes are only clear in hindsight, there is real risk that the USD could see significant pullbacks on any sudden EURUSD short covering.

It will be critical to watch how the US Dollar trades through the first week of January. Typically we see highs and lows for the month set in the first and last week of the period. If the USD trades significantly lower, we could see a larger pullback into the final week of January.

Watch a presentation on how you can use FX Options risk reversals and this report in your swing trades.

Risk Reversals
EUR/USD GBP/USD USD/JPY USD/CAD USD/CHF AUD/USD NZD/USD
1-Week 98.86% 91.36% 30.38% 1.15% 8.43% 86.21% 85.23%
1-Month 100.00% 100.00% 86.25% 2.35% 18.52% 43.10% 98.88%
3-Month 100.00% 96.10% 96.34% 19.28% 17.05% 93.02% 93.18%
12-Month 100.00% 93.06% 100.00% 30.49% 50.00% 91.67% 96.55%
DailyFX Volatility Index Percentiles
Volatility Index 1 Week 2 Weeks 1 Month 3 Months 1 Year
Indices 16.92% 15.38% 13.85% 1.56% 7.69%

forex_options_us_dollar_forecast_lower_body_Picture_1.png, US Dollar Poised for Declines on Trader Sentiment Extremes

Euro/US Dollar Options Analysis

forex_options_us_dollar_forecast_lower_body_Picture_2.png, US Dollar Poised for Declines on Trader Sentiment Extremes

Net Non-Commercial COT Futures Positioning (rhs)

1-Week Risk Reversal Percentile (lhs)

3-Month Risk Reversal Percentiles (lhs)

FX Options trading bias: Contrarian Bullish

Speculative futures traders are their most net-short the Euro against the US Dollar in history, while FX options traders have aggressively bet on and hedged against EURUSD rallies. The noteworthy divergence warns that the Euro may be at an important sentiment extreme and there is high risk of short-term reversal higher.

As is always the case, sentiment extremes and tops and bottoms are only clear in hindsight. We warn against getting aggressively long the EURUSD as it trades near fresh lows. Instead we might wait to see how the EUR closes the first week of January as a predictor of what it might do for the rest of the month. If we see a sharp bounce, it might be worthwhile to trade the pair higher into the remainder of January.

Australian Dollar/US Dollar Options Analysis

forex_options_us_dollar_forecast_lower_body_Picture_3.png, US Dollar Poised for Declines on Trader Sentiment Extremes

Net Non-Commercial COT Futures Positioning

1-Week Risk Reversal Percentile

3-Month Risk Reversal Percentiles

FX Options trading bias: Bullish

Both speculative futures traders and FX options markets are betting on and hedging against continued AUDUSD strength, giving us an overall bullish Australian Dollar trading bias. In fact, Net Non-commercial futures positioning is fairly modest by historical standards. In other words, there is plenty of room for further traders to go long as the pair hits fresh highs.

The clear risk to said analysis is a sharp correction in the highly-correlated US S&P 500 and broader financial markets. Yet all else remaining equal, we might expect the AUD to hit fresh highs before any important pullbacks.

British Pound/US Dollar Options Analysis

forex_options_us_dollar_forecast_lower_body_Picture_4.png, US Dollar Poised for Declines on Trader Sentiment Extremes

Net Non-Commercial COT Futures Positioning

1-Week Risk Reversal Percentile

3-Month Risk Reversal Percentiles

FX Options trading bias: Contrarian Bullish

Speculative futures traders remain net-short the British Pound against the US Dollar, but a sharp jump in FX Options risk reversals suggests many traders have shifted towards betting on and hedging against continued GBPUSD strength.

Indeed, it seems as though the GBPUSD may have further room to rally as traders cover short positions. We remain bullish—especially on a break of multi-month highs near $1.5800.

New Zealand Dollar/US Options Analysis

forex_options_us_dollar_forecast_lower_body_Picture_5.png, US Dollar Poised for Declines on Trader Sentiment Extremes

Net Non-Commercial COT Futures Positioning

1-Week Risk Reversal Percentile

3-Month Risk Reversal Percentiles

FX Options trading bias: Contrarian Bullish

New Zealand Dollar positioning shows that there is fairly significant room for fresh NZDUSD highs through upcoming trade. Speculative futures traders are basically their least bullish NZD since the pair set a significant bottom through early 2011. All the while, FX Options traders have shifted towards aggressive bets on and hedges against NZD strength.

As with the Australian Dollar, we see current FX futures and options positioning as supportive of further NZDUSD gains.

US Dollar/Japanese Yen Options Analysis

forex_options_us_dollar_forecast_lower_body_Picture_6.png, US Dollar Poised for Declines on Trader Sentiment Extremes

Net Non-Commercial COT Futures Positioning

1-Week Risk Reversal Percentile

3-Month Risk Reversal Percentiles

FX Options trading bias: Bullish

FX options traders are their most bullish USDJPY in at least 8 years, suggesting most have been betting on and hedging against Japanese Yen weakness (USDJPY gains). Speculative futures traders are likewise at their least short USDJPY since the pair last traded above the 80 mark, and overall it seems most are positioned for an important USDJPY reversal.

We have and will continue to warn that major tops and bottoms are only clear in hindsight. Yet there is evidence to suggest that the USDJPY could soon set an important reversal.

US Dollar/Swiss Franc Options Analysis

forex_options_us_dollar_forecast_lower_body_Picture_7.png, US Dollar Poised for Declines on Trader Sentiment Extremes

Net Non-Commercial COT Futures Positioning

1-Week Risk Reversal Percentile

3-Month Risk Reversal Percentiles

FX Options trading bias: Bullish

Futures traders remain aggressively net-long the US Dollar against the Swiss Franc, and the potential sentiment extreme warns that the pair could soon turn lower.

FX Options traders have indeed shifted towards betting on and hedging against USDCHF weakness. On balance, we see risks of an important USDCHF pullback.

US Dollar/Canadian Dollar Options Analysis

forex_options_us_dollar_forecast_lower_body_Picture_8.png, US Dollar Poised for Declines on Trader Sentiment Extremes

Net Non-Commercial COT Futures Positioning (rhs)

1-Week Risk Reversal Percentile (lhs)

3-Month Risk Reversal Percentiles (lhs)

FX Options trading bias: Bearish

CFTC Commitment of Traders data recently showed that Non-Commercial trades remained near their most net-long USDCAD since 2009—at which point the USDCAD set an important high near the C$1.20 mark and continued lower.

Already we’ve seen the USDCAD pull back significantly off of recent peaks near the C$1.0500 mark, and the question now becomes whether we can expect further corrections through upcoming trade. The sharp turn lower in FX Options risk reversals suggests that traders are betting on and hedging against continued USDCAD weakness.

— Written by David Rodriguez, Quantitative Strategist for DailyFX.com

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