US Dollar Targets Fresh Lows versus Euro, Australian Dollar

DailyFX   |  February 8 2012 5:00 EST

Forex options and futures sentiment points to further US Dollar (ticker: USDOLLAR) losses, and we expect the EURUSD, AUDUSD, NZDUSD, and GBPUSD could trade to further highs.

Forex options and futures sentiment points to further US Dollar (ticker: USDOLLAR) losses, and we expect the EURUSD, AUDUSD, NZDUSD, and GBPUSD could trade to further highs.

FX Options traders have swiftly shifted towards bets on and hedges against US Dollar weakness. That is to say: traders are their most bearish USD in quite some time. All the while, speculative futures positioning shows a very large overhang of USD-long positions. In this author’s opinion, the mix creates the perfect storm for a sharp EURUSD short-covering rally.

The question clearly becomes whether we can expect recent US Dollar losses to continue. Given that the safe-haven US currency tends to appreciate when markets flock to safer assets, we would expect it to bounce on any major market turmoil. Yet volatility expectations are near their lowest since the onset of the financial crisis, and recent trends plainly favor continued USD losses.

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Euro/US Dollar Options Analysis

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 have remained exceedingly net-short the Euro against the US Dollar through the past several months of declines. And though we continued to warn that sentiment extremes are only clear in hindsight, such one-sided positioned warned that a sharp reversal was increasingly likely. Of course, that’s all in the past—what do we currently see for price action?

COT data shows that Non-commercials (large speculators) are still extremely net-short Euros against the US Dollar. The sharp rallies in the EURUSD are, in this author’s opinion, a product of important short covering and a return to more “normal” levels of trader positioning. Perhaps surprisingly, however, COT data shows speculators are extremely net short despite the 600+ pip rally off of the lows.

What’s next? Further short covering would likely encourage further Euro strength. Indeed, exceedingly low FX Options market volatility suggests the safe-haven US currency may continue to slide against the Euro.

Australian Dollar/US Dollar Options Analysis

Net Non-Commercial COT Futures Positioning

1-Week Risk Reversal Percentile

3-Month Risk Reversal Percentiles

FX Options trading bias: Bullish

Speculative futures traders are their most net-long the Australian Dollar against the US Dollar since the pair set a substantial top in July, warning that positioning is fast becoming unsustainable. Of course, positioning can remain extreme for weeks on end, and indeed broader momentum favors continued AUDUSD strength.

FX Options traders are similarly at their most (relatively) bullish since that significant July top. Yet the real question is: how long can positioning remain so one-sided.

Exceedingly low volatility expectations favor further Australian Dollar strength against the safe-haven US Dollar. The turn lower in the AUDUSD, when it comes, may be severe. Yet it seems ill-advised to go against such strong momentum.

US Dollar/Japanese Yen Options Analysis

Net Non-Commercial COT Futures Positioning

1-Week Risk Reversal Percentile

3-Month Risk Reversal Percentiles

FX Options trading bias: Bullish

FX options traders remain their most bullish USDJPY in at least 8 years, suggesting most have been betting on and hedging against Japanese Yen weakness (USDJPY gains). Yet speculative futures traders are heavily net-short USDJPY (long JPY), and current price momentum plainly favors USDJPY weakness.

The USDJPY exchange rate has not yet tested fresh record lows, and we are reluctant to become aggressively short the USDJPY at the risk that there will be little follow-through.

The fact that options traders are not willing to bet on or hedge against USDJPY declines shows little confidence in the current downtrend. We may look for USDJPY buying opportunities once price reaches a fresh record low and shows reasonable likelihood of reversal.

British Pound/US Dollar Options Analysis

Net Non-Commercial COT Futures Positioning

1-Week Risk Reversal Percentile

3-Month Risk Reversal Percentiles

FX Options trading bias: Contrarian Bullish

Recent British Pound gains have been nothing short of impressive, and indeed we see that futures and options trader sentiment has shifted in favor of further strength. Non-commercial futures are still strongly net-short, but traders are their least bearish since December. Further short covering could push the British Pound to fresh short-term highs against its US counterpart.

FX Options sentiment has moderated somewhat, but the recent shift towards bets on and hedges against GBP strength are relatively clear. We remain bullish the GBPUSD until we see real signs of potential reversal.

New Zealand Dollar/US Options Analysis

Net Non-Commercial COT Futures Positioning

1-Week Risk Reversal Percentile

3-Month Risk Reversal Percentiles

FX Options trading bias: Contrarian Bullish

FX Futures speculators and options traders are their most bullish the New Zealand Dollar since Q3, 2011—at which point the NDZUSD set a significant top and turned lower. Yet as we continue to emphasize: positioning can remain extreme for weeks and even months at a time.

As with the Australian Dollar, we see current FX futures and options positioning as supportive of further NZDUSD gains. The turn could be swift and sharp, but we won’t sell into such sharp upward momentum.

US Dollar/Swiss Franc Options Analysis

Net Non-Commercial COT Futures Positioning

1-Week Risk Reversal Percentile

3-Month Risk Reversal Percentiles

FX Options trading bias: Contrarian Bearish

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

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

US Dollar/Canadian Dollar Options Analysis

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.

The USDCAD has since turned sharply lower, and indeed FX Options traders have shifted in favor of further weakness. We believe that the USDCAD may continue to set fresh lows as the US Dollar continues to fall across the board.

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

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