What to see from certain market positions?

Positioning data revealed by the CFTC suggests that speculative traders have racked up very large levels of long-dollar/yen positions.

We saw some very sharp movements in asset prices last week. The US dollar slumped, bond yields cratered and stocks soared. It appeared excessive given that it all seemed to be built on a one-tenth undershoot of US CPI data. Does this suggest that liquidity-starved summer trading markets and incorrect positioning might have been the real reason for the moves and not a fundamental re-assessment of the economic picture?

When prices move quickly like this it is inevitable that traders and investors suspect that a big fundamental change has occurred. In this case, the CPI undershoot, albeit small, seems to have emboldened the idea that the Fed might now be trying to beat a defeated enemy; inflation. Rates might rise once more but then the spectre of rate cuts will loom into view and that’s something that dollar bears and bond market bulls want to position themselves for now, not in the future.

While there’s a fundamental story here that can be concocted, another argument is that this is all just summer-market volatility bought about by poor liquidity and, in some cases by “incorrect” positioning which is being quickly reversed. Is there any validity in this latter explanation and, if so, does it suggest that US dollar weakness, declines in bond yields and rallies in stocks will all fizzle out pretty soon?

We can certainly make the case that positioning in some markets has been overextended. Take dollar/yen, for instance. The yen has been plummeting against the US dollar, and other currencies and positioning data revealed by the Commodities and Futures Trade Commission (CFTC) suggests that speculative traders have racked up very large levels of long-dollar/yen positions; the most in over five years.

Quite clearly there have also been some other reasons for the yen’s recent rebound besides the low US CPI print, such as speculation of a change in the BoJ’s yield curve control policy later this month, but it is still hard to argue with the fact that excessive short positioning in the yen could have played a big part as well in yen’s rebound against the US dollar.

“We could make similar conclusions from the positioning of non-commercial traders in the treasury market. In the key 10-year T-note future, for instance the number of net short contracts is just about at record levels. Now there is admittedly, some discrepancy between the extent of short positions in the CFTC data and evidence of large, long positions amongst longer-term institutional traders as well as speculation that short futures positions reflect basis trading rather than outright bearish positioning”, said Mr. Steve Barrow, Head of Standard Bank G10 Strategy.

Nonetheless, the fact that treasury yields fell so quickly and substantially last week talks to the fact that at least some of this slide was probably down to swift position unwinding by the bears as opposed to new long positions from any bulls.

Is the slump in the US dollar and yields all a temporary position-driven summer phenomenon that will stop very soon, or could it mark a more fundamental shift that will endure? Despite the data on positioning, Mr. Steve Barrow leans towards the view that it is more “fundamental” in nature and hence the moves will persist rather than fizzle out. However, perhaps there should be a word of warning here if we are talking about over-extended positioning. This relates to euro/dollar; for the same CFTC data shows that net long-euro positions against the dollar have been standing at very high levels recently, surpassed only in August 2020, just before euro/dollar slipped from the highs then of 1.2250 to below parity two years later.

Of course, if long positions in euro/dollar are overextended, it did not prevent the euro rising sharply last week. But we still might want to be aware that positioning could weigh on the ability of the euro to benefit from the dollar’s weakness and that might allow other currencies to outperform the euro. It seems that this might have already happened when it comes to the pound as market positioning here has been far more defensive than that we have seen for the euro.