speculative positioning

FX Daily: How much more fuel in the disinflation tank? Last week’s US disinflation shock altered the FX landscape, but a few days without key data releases will tell us whether that impulse can keep the dollar on the back foot as the FOMC risk event draws nearer. EUR/USD appears a bit overstretched in the short term and could face a correction this week.   USD: Some caveats to the bearish narrative On Friday, we published FX Talking: The dollar’s break point, where we discuss our updated views on G10 and EM currencies and present our latest forecasts. The radical shift in the FX positioning picture since the US CPI and PPI releases last week now forces a reassessment of the dollar outlook. The Commodity Futures Trading Commission (CFTC) data on speculative positioning offers little help in understanding how much dollar positioning has changed since the latest reported positions were as of Tuesday, before the inflation report. Back then, the weighted aggregate positioning against reported G9 currencies (i.e., G10 excluding SEK and NOK) had already inched into net-short territory (-2% of open interest, in our calculations). When making the parallel with the November-December 2022 dollar decline, positioning shows a key difference. At the end of October 2022, markets were still speculatively long on the dollar (around 10% of open interest against CFTC-reported G9). Another important factor – especially for EUR/USD – is the degree to which other central banks outside of the US can still surprise on the hawkish side, which is significantly lower than it was last autumn. These caveats to the rather compelling bearish dollar story mean that it may not be one-way traffic from here in FX, even if we see the dollar weaken further into year-end. On the fundamental side, the disinflation story puts risk assets on a sweet spot, favours a re-steepening of the US yield curve and should make pro-cyclical currencies more attractive. However, the Federal Reserve may not turn into a USD-negative that swiftly. Our US economist still sees a 25bp hike next week as likely. It is fully priced in, but will the Fed be ready to throw the towel on more hikes just yet? Core inflation is declining, but the jobs market remains very tight and other economic indicators remain resilient. The dot plot is still showing another hike before a peak and Fed Chair Jerome Powell may prefer to err on the hawkish side, especially through a rate cut pushback (first cut priced in for the first quarter of 2024). This week will be interesting to watch since the lack of tier-one data in the US will offer a clue on how FX markets will trade from now on; the question is whether investors now see enough reasons to add short positions on the dollar ahead of the FOMC or take a more cautious approach. The latter – which appears marginally more likely in our eyes – may see the dollar reclaim some portions of recent losses. DXY could find some support after climbing back above 100.00.

Middle distillates to remain well supported Like last year, the middle distillate market has led the strength amongst refined products. The ICE gasoil crack has traded as high as $45/bbl recently, with the NYMEX heating oil crack hitting highs of more than $50/bbl while Singapore gasoil cracks briefly traded a little over $35/bbl in August. Declining middle distillate inventories have helped to push the market higher, with stocks well below the five-year average in most regions including the US, ARA in Europe and Singapore. The concern is that inventories have been falling and are already low as we head into the northern hemisphere winter, a period where you would expect to see stronger demand. This suggests that middle distillate cracks are likely to be fairly well supported. In Europe, a key issue has been the ability of buyers to replace Russian products. Prior to the EU ban on Russian refined products, Russian gasoil flows to the EU were about 450Mbbls/d. In the lead-up to the ban, there was some front-loading, evident in the buildup of inventory over the latter part of 2022 and into early 2023. Since the ban, the EU has turned to other origins, however, it would appear that this is not enough to fully make up for the loss of Russian supply. As a result, we have seen ARA gasoil inventories steadily declining since late February. Recovering air travel has also played an important role in the renewed strength seen in middle distillates. This is evident in the widening of jet fuel’s premium to gasoil in north-west Europe, whilst the Asian regrade discount continues to narrow. This shouldn’t be too surprising given that air traffic continues to move towards more normal levels. The latest data from the International Air Transport Association show that air passenger traffic (revenue passenger kilometres) in July was 4.4% below the same period in 2019. In fact, in North America and Latin America, passenger traffic is back above 2019 levels. However, Asia is still lagging with passenger traffic 8.8% below 2019 levels. While we could see a seasonal slowdown in jet demand with the end of the northern hemisphere summer holidays, we should continue to see a recovery year-on-year, driven predominantly by Asia. In addition, ongoing OPEC+ supply cuts have led to distortions in the crude oil market, which has fed through to the product markets. These cuts have led to a tightening in the medium sour crude market, which will have an impact on refinery yields, with refiners yielding lighter products as a result. A tightening in gasoil has also attracted speculators to the market or at least has seen a drastic shift in their positioning. This is evident when looking at speculative positioning in ICE gasoil. The managed money position has increased from a net short of almost 33k lots in early May to a net long of almost 94k lots by mid-August – 127k lots of buying, which is close to 95m barrels of buying. Our view is that middle distillate cracks should remain relatively well supported for the remainder of the year at around US$30/bbl, whilst through 2024 we expect the crack to average a little over US$20/bbl.

GBP: Rolling lower As we discussed in yesterday's FX Daily, the market did read the latest wage developments slightly dovishly and re-priced both the Bank of England tightening cycle and sterling lower. It is quite incredible to see the Bank Rate now priced just above 5.50% next February. This terminal rate had been priced close to 6.50% just a few months ago. If we are right with our call for an ECB rate hike tomorrow, EUR/GBP could edge up towards the 0.8670 area. And given that we like a continued strong dollar in the short term, expect GBP/USD to press the 200-day moving average at 1.2430. Recall that based on speculative positioning data, both the euro and sterling look the most vulnerable to further dollar strength.

GBP Rolling lower As we discussed in yesterday's FX Daily, the market did read the latest wage developments slightly dovishly and re-priced both the Bank of England tightening cycle and sterling lower. It is quite incredible to see the Bank Rate now priced just above 5.50% next February. This terminal rate had been priced close to 6.50% just a few months ago. If we are right with our call for an ECB rate hike tomorrow, EUR/GBP could edge up towards the 0.8670 area. And given that we like a continued strong dollar in the short term, expect GBP/USD to press the 200-day moving average at 1.2430. Recall that based on speculative positioning data, both the euro and sterling look the most vulnerable to further dollar strength. Chris Turner    

EUR: Back-end yield premium weighing on the euro The 10bp tightening in the EUR/USD 2-year swap rate differential on Friday was completely erased on Monday, with the spread once again at a -120bp level. Such a wide gap was observed in two other periods in 2023 – at the very beginning of January and throughout February and March. Interestingly, EUR/USD never traded below 1.0500 in those periods, a testament to the back-end US-yields premium currently adding pressure on the pair. The Bund-UST 10-year spread has widened by nearly 60bp since mid-June, now at a -177bp low as seen in November 2022. Latest CFTC figures on speculative positioning suggest EUR/USD still had some residual net-longs (+14% of open interest) to be unwound, and the ever-deteriorating rate gap with the dollar means that 1.0400 may well be tested this week. As discussed above, swings in the volatile bond market will likely determine when that can happen. In a recent note, we estimated EUR/USD would fall to the 1.02 area should 10-year yields hit 5.0%. Domestically, the eurozone data calendar is empty today, but we’ll hear from a few European Central Bank speakers, including Philip Lane and Francois Villeroy.

According to the latest CFTC report, the past week was relatively calm in the futures market. One notable change was the value of the net short yen by position, which corrected by 1.2 billion, while changes in other currencies were minimal. The US dollar's net positioning, after sharply rising the previous week, saw a 0.3 billion correction, bringing it to 8.5 billion, indicating a firm speculative positioning for the dollar. Other factors that supported the greenback are the drop in the number of long positions in oil and especially gold, with a weekly change of -4.8 billion, implying further declines. This often signifies growing bullish sentiment for the US dollar.   The University of Michigan's Consumer Sentiment Index fell to 63.0 in October, the reading was below the forecast of 67.2, reaching the lowest level since May. This marks the third consecutive decline and can be largely attributed to rising gas prices and a decline in the stock market. However, consumer spending remains at a good level despite weaker sentiment in recent months. China's consumer price index remained flat from a year earlier in September, while the Producer Price Index fell by 2.5% as concerns linger about weak demand. Both figures were slightly below consensus estimates. This week's data on industrial production, retail sales, and third-quarter GDP will provide a clearer picture of the impact of the government's additional stimulus measures. The conflict between Israel and Hamas has quickly escalated into the bloodiest clash in the past 50 years from both sides. As both Israel and Iran are minor natural gas exporters, European natural gas prices rose by about 40% last week. Oil markets remain calmer due to reduced demand and excess production capacity. US consumer price inflation for September shows headline prices rose 0.4% month-on-month (consensus 0.3%), and the core index slowed down from 4.3% year-on-year to 4.1% year-on-year, which is a positive sign for the Federal Reserve. There is growing confidence that the Fed's rate hike cycle is coming to an end.   The British pound corrected slightly above the resistance level at 1.2305 and then resumed its decline. It is assumed that the local peak has been formed, and the sell-off will continue, with the nearest target being 1.2033 (the low from October 4). In case it breaks below this level, selling pressure may intensify, with the long-term target being 1.1740/90.