In the FX world, everyone is talking about the US Dollar selloff and there are even talks of the greenback losing its reserve status and what not. Generally, when people get very bearish (or bullish) something, that’s when the market does the opposite. Bloomberg reported that traders are the most bearish on the USD in five years. That’s something.
I generally don’t look too much inot the CoT report, but it catches my attention when I see the price diverging with the futures positioning. That’s often a sign that we are near a top or bottom. The problem is that the CoT is a lagging indicator since it’s reported with a one week lag. But it’s a warning sign nonetheless.
In the chart above, you can see that the EURUSD price (black line) surged into new cycle highs, while the CoT (blue line) actually fell in the most recent update (that included already a new high in the price). So, we are having a divergence. If you look left, you can see that such divergences preceded reversals.
Now, the main driver of major FX pairs are yield differentials. In the chart below, we can see that the EURUSD price (red line) is diverging massively with the EU/US differential (blue line). Something has to give (granted that yields might be undergoing technical distortions and not being fundamentally driven).
The problem right now is that we are having strong dislocations in markets and it’s hard to distinguish the signal from the noise. Fundamentally, I can see the reason for the US Dollar to depreciate in the medium to long term, but in the short term, shorts got overstretched on the basis of aggressive Fed cuts probably. And the Fed is unlikely to cut unless we go into a recession.
So, the risks to USD shorts (in the short term) will probably come from positive signs on negotiations with China and a general de-escalation so that the aggressive rate cuts bets get unwound (most likely scenario) or the Fed starts to put on the table rate hikes (which is the most unlikely scenario right now).
