The U.S dollar has further to rise

The sterling will slide to the 1.15 region against the dollar while the euro still seems to have 95 cents written all over it against the greenback.        

For instance, bearishness towards equities has been very substantial according to many surveys. We have also seen long positioning in the dollar increase to very lofty levels. But as hints emerge of a change in the narrative this extreme positioning can lead to very sharp reversals. We have seen this already in equities in the past month, or so, and now we wait to see if the dollar will be subject to an equally vicious turnaround.

There’s many ways in which we can try to ascertain whether positioning has reached extremely bullish or extremely bearish levels. In stocks, the plethora of investor surveys on asset allocation help shape our view of market positioning.

On this score we’d mention the American Association of Individual Investors (AAII) which shows stock fund allocations are currently in the 33% region which is way down on the 39% seen a year ago and on a par with the depths of market sentiment seen in March 2020 as Covid raged.

At the same time the 23% that’s currently allocated to cash is the highest since April 2020. Other surveys have given the impression of deep despair among equity market participants and a low level of cash being put to work. But, as we’ve seen, if there’s a glimmer of hope in the news, such as US corporate results or yesterday’s lower-than-expected US CPI data, stocks can ratchet higher.

Indeed, even without such ‘good’ news, the very bearish positioning of the market hints that the bears need a clear flow of bad news to keep bourses under pressure. In other words, no news might be good news for stocks such is the bearish positioning of the market. The net result of all this is that the MSCI global equity index has recovered more than a third of its H1 2022 slump in the first six weeks of H2 22.

The same sorts of arguments can be applied to the dollar. But here survey data is arguably of more limit ed use. Instead, we think it is better to look at data that might give a clue to positioning. Here we’d look to the CFTC data on the positioning of non-commercial (speculative) traders and that’s certainly told a bullish story for the dollar with net long dollar positions some USD17.3bn against other major currencies at the last count which is large by historical standards.

Option risk reversals are another way of showing just how much the market puts a premium on owning dollar call options over dollar puts. Right now, these readings are very consistent with the idea that the market is still leaning very heavily in the dollar’s favour. But now, with perhaps the first notable chink in the story of never-ending US inflation coming through in the CPI, we need to ask whether significant long-dollar positioning will provoke the same sort of sharp reversal that we’ve already started to see in equities.

In our view it will not – and we even remain sceptical that the bounce we’ve seen in stocks in recent weeks heralds a long-lasting reversal of the H1 2022 slump. At the same time, we don’t doubt that these markets could become a little less one-sided than we’ve seen for most of this year as extremely bearish stock and bullish dollar positioning is unwound, but, in general, we still think the dollar has further to rise and stocks have further to fall.

For a start, an ‘all clear’ on inflation is not at hand and hence the Fed is still a very long way from delivering the sort of rate-cut profile that the market is desperate to price in for next year.

Another concern we have is that economic conditions in Europe are going to become incredibly tough over the winter period as the surge in energy prices really starts to bite. A new crisis in the euro zone is certainly not off the radar screen while the UK’s economic fundamentals seem to be more indicative of an emerging market country and not a developed country at the moment. Hence, we still think that sterling will slide to the 1.15 region against the dollar while the euro still seems to have 95 cents written all over it against the greenback.