Currencies | Jan 20 2011
By David Rodriguez, Quantitative Strategist for DailyFX
Sharp US Dollar declines have been met with a similarly pronounced shift in FX Options sentiment, and it seems that many traders have begun to bet on and hedge against further USD weakness. Such a shift warns against taking aggressive short-term bets on US Dollar strength.
We continue to argue that the US Dollar may continue to strengthen in 2011. Yet it is particularly difficult to call for shorter-term recovery amidst a pronounced turnaround in market sentiment. We will need to wait for a considerable improvement in US Dollar sentiment before making more aggressive calls for a sustained reversal.
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Continued Euro/US Dollar strength has been met with an impressive correction in FX Options risk reversals, and the sharp sentiment shift warns against betting on a EUR reversal. It is nonetheless surprising to note that FX Futures data shows Non-commercial traders at their most net-short since the pair traded near the $1.20 mark, and it is admittedly difficult to get a handle on what to expect given such diverging views.
Absent a material shift in either options or futures data, we have little choice but to remain neutral the EUR/USD until further notice.
Impressive British Pound strength has been met with a similarly sharp shift in FX Options risk reversals, and overall sentiment suggests that the pair could continue higher through the near term. Options show that traders have begun to bet on and hedge against further GBP rallies, and shorter-dated options are now near their most bullish in the past three months. Though our benchmark ‘breakout style’ FX Options risk reversals system will wait until further extremes before taking a long position, overall momentum continues to favor GBP gains.
Our breakout-style risk reversals system is on the verge of closing its long-standing hypothetical USDJPY long position as sentiment corrects sharply from previous extremes. We have long called for a substantive USDJPY bounce on heavily one-sided FX Options sentiment and overstretched futures positioning. And though the USDJPY continues to hold its lows (as we said it should), the lack of conviction to the topside has made taking a long position difficult.
The breakout-style system hypothetically remains long from November 10 at approximately the 82.30 mark. Absent a material shift in FX Options sentiment, we have little choice but remain short-term neutral the USDJPY.
Our outlook on the USDCAD is effectively unchanged from two weeks ago: “Substantial Canadian Dollar strength has sent the USDCAD to fresh lows, but FX Options risk reversals have not followed suit and point to a clear divergence in sentiment and price action. Such a divergence does not rule out further short-term weakness, but it suggests that options traders are not betting on or hedging against further USDCAD weakness at these significant lows.” It also serves to note that FX Futures positioning shows Non-Commercial traders at their most net-short the USDCAD (long the Canadian Dollar) since the pair last hit parity and subsequently reversed.
Timing turnarounds is exceedingly difficult, but it seems imprudent to take major bets on further USDCAD weakness on sentiment extremes.
Our FX Options and Futures-based forecasts for the US Dollar/Swiss Franc pair have been fairly mixed as of late, and a rather large divergence in sentiment makes taking a strong stance on short-term price action similarly difficult. On the one hand, Non-Commercial futures positioning shows that speculators remain aggressively short the USDCHF, while options traders are—at least at the margins—betting on and hedging against strength.
Given the pair’s sharp overall downtrend, the risk of corrections on USDCHF short-covering is high. Yet timing reversals is very tricky, and we are especially hesitant to call for USDCHF strength absent a sharper move in FX Options risk reversals.
The Australian Dollar has bounced noticeably from recent short-term lows, and a commensurate shift in FX Options risk reversals suggests many have begun to bet on and hedge against further AUDUSD strength. The choppiness in price action and sentiment has made it exceedingly difficult to establish any sort of lasting bias on said currency pair. FX Futures data shows Non-Commercial traders hit major net-long extremes before pulling back as the pair similarly failed to hold its highs.
Such reversals typically come at a major price extreme and suggests that the Australian Dollar could have set a significant price high through previous trading. Yet timing a short position has proved very difficult, and the recent bounce in Risk Reversals warns against overleveraging oneself to the downside.
The New Zealand dollar has seen a similarly substantive shift in FX Options risk reversals, warning against taking aggressive shorts on the suddenly resurgent currency pair. The shift in sentiment suggests many have begun betting on and hedging against further NZDUSD rallies. And though we have remained steadfastly bearish the NZD for quite some time now, the short-term picture is clouded significantly by the sudden jump in risk reversals. We maintain that the NZD set an important high through the end of 2010, but taking short-term bets has become considerably more complicated amidst a potentially important swing in sentiment.
The views expressed are not FNArena's (see our disclaimer).
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Technical limitations
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