FX Positioning: Sell the dollar, sell the risk

CFTC positioning data is reported with approximately a one week delay. In normal market conditions, this data hardly loses explanatory power in just one week. But when reading into positioning data under current highly volatile conditions, a large degree of caution is warranted, as the actual values may have changed drastically.

CFTC data ending 24 March (Figure 1) displays a very different picture compared to the latest positioning note we published in early March. After the rise and fall of the dollar over the past two weeks, aggregate net positioning of the USD versus the reported G10 currencies (hence, not including Scandies) has moved into marginally negative territory for the first time since June 2018.

Quite interestingly, there is a big dislocation between speculative positioning and the dollar dynamics in the spot market over the past few weeks. While USD rose to record highs in March – before giving up some of its gains in the past few days – speculative positions actually turned decisively against the dollar (as shown in Figure 2 below).

As highlighted above, this data must indeed be taken with a pinch of salt given the current exceptional situation, but this might indicate some reluctance among speculative investors to bet on the dollar as the Federal Reserve was implementing an unprecedented quantitative easing scheme. As we discuss below, CFTC data suggests a preference among speculators for G10 low-yielders rather than the USD to navigate the risk-off environment.

The yen was the biggest G10 long as of 24 March. We have recently highlighted a few reasons why the JPY has room to appreciate in the near future,and it is no surprise speculators have increased their long JPY bets ahead of the looming global recession.

The Swiss franc is also well into net long territory. Here, the franc's role as the quintessential hedge to financial distress, particularly in Europe, offers additional room for appreciation. Obviously, the key caveat is the Swiss National Bank’s determination to curb CHF appreciation, especially after the Bank made clear in its latest policy meeting that FX interventions are the preferred monetary tool. This key factor may still be the reason why investors find more appetite for the JPY rather than CHF as a global recession unfolds.

In line with the reallocation towards defensive currencies, the commodity bloc in the G10 is what speculators see as the most valuable short in the group due to its high beta to global sentiment.

However, there is some divergence in terms of market positioning within this segment that is worth analysing. While the New Zealand dollar is by far the biggest short (-43% of open interest) in the G10 – this was also the case for most of 4Q19 – its closest peer, the Australian dollar has net short positions amounting to less than half (-19%). The Canadian dollar stands in the middle, with -24% of open interest.

We struggle to identify the main reason for such dislocation in the fundamentals, as all $/bloc central banks had adopted an ultra-dovish stance (the Bank of Canada cut and QE is not covered by the data, but had largely been priced in already) and the economic impact may arguably be larger in Canada than in New Zealand, due to the exposure to dropping oil prices.

Instead, this divergence within the $-bloc may well be a function of each currency’s liquidity. As highlighted in “FX vulnerability and the liquidity factor”, when lack of liquidity fears take centre stage in the markets, the least liquid currencies tend to underperform. As shown in the BIS turnover data below (Figure 3), AUD is the most liquid in the $-bloc, followed by CAD, while the NZD is amongst the least liquid currencies in the whole G10 space – which mirrors the divergence in positioning data.