Dollar Shorts at Highest Since Pre-Crisis

FX Commentary From CMC Markets UK For May 26, 2009

This week’s $100 billion in new US Treasury auctions of 2, 5 and 7-year notes appears likely to undergo extra scrutiny regarding the appetite from foreign investors considering the vicious feedback loop that has been weighing on the value of the US dollar and the price of US treasuries. Last week’s close above the $1.40 level in EURUSD was among the high profile technical signals supporting the potential for prolonged EUR strength ahead against USD, which could serve as a proxy for the broader USD flows. A weekly close below $1.37 in EURUSD would appear necessary to deal any serious relief to USD-sentiment.

Last week’s data from currency futures showed EUR longs vs. USD exceeded the shorts by 12,250 contracts—the highest level since the week of July 15 (the week when EURUSD hit its record high). Meanwhile, JPY longs vs. USD exceeded the shorts by 6,000 contracts, the highest since March. Aussie net longs vs. USD also hit their highest since July, reflecting the extent of apparently deepening anti-USD sentiment among the speculative (non-commercial) community. Considering that EUR and JPY net longs vs. USD are about 11 times lower than their record highs, speculators seem to have plenty of upside against the USD in terms of quantity as well as price. Any signs of weakness in Wednesday’s auction of $35 bln in 5-year T-notes and Thursday’s auction of $25 bln in 7-year T-notes may give more fundamental leeway for speculators to pile on shorting the US currency and build up a gradual path towards $1.47 vs. EUR and 91 yen.
FX carry trades searching the extra yield away from USD and JPY into commodity and EM currencies may closely watch the ensuing retreat in risk appetite, particularly the 880, 8,200 and 4,300 levels in the S&P500, Dow-30 and FTSE-100 respectively. These levels acted as substantial points of resistance in April, which have now turned to considerable points of support. A breach below these levels would be the next litmus test for whether dollar stability will re-establish itself under rising risk aversion. The gauges of the “sell-US assets trade have been cogently manifested last week via a rare negative trifecta of falling USD index, falling treasury prices and falling equity indices.