LONDON (Reuters) - Hedge funds and speculators spent the first four months of the year betting heavily against the dollar. They’re now running for the hills.
The increasingly rapid rate at which they’re slashing their short dollar positions is creating a vicious cycle: short covering accelerates the dollar’s rally, which forces even more short covering, which pushes the dollar even higher.
The bad news for those clinging to the view that the dollar is heading lower is it looks like this “pain trade” has further to run because, historically, the overall short position remains large.
The latest Commodity Futures Trading Commission figures show that hedge funds and speculators cut their net short dollar position against a range of developed and emerging currencies by $5.5 billion in the week to May 1.
That was the biggest cut this year and brings the reduction in the last two weeks of April to nearly $10 billion. It’s a rapid reversal, which undoubtedly helped the dollar rally nearly 4 percent in that period.
But the net short position is still worth $18.32 billion, compared with the average weekly position over the past decade, which is a net long $5.4 billion. The dollar appreciated a further 1 percent in the first week of May, suggesting the short covering continues at pace.
(For a graphic showing CFTC net dollar position, click here: https://reut.rs/2K2gsep)
(For a graphic showing CFTC dollar position - weekly change, click here: https://reut.rs/2K46WYp)
A short position is effectively a bet that the price of an asset will fall, and a long position is a bet it will rise in value.
The biggest shifts in the latest week were against the euro and sterling.
Speculative accounts on the CFTC cut their net long euro position by just over 10,000 contracts to 120,568, the smallest long position of the year. Two weeks earlier, they held a record net long 151,476 contracts.
“As of last Tuesday, the net euro long hadn’t corrected enough to give a committed euro dip-buyer any encouragement at all,” reckons Societe Generale’s Kit Jukes.
Similarly, CFTC speculators cut their net long sterling position by nearly 11,000 contracts, which means they have almost halved the net long position in just a fortnight.
The euro is now trading below $1.20, down nearly 4 pct against the dollar since April 17, and the pound is down more than 6 pct at $1.35.
While the rise in U.S. bond yields appears to have stalled for now, with the 10-year yield back below 3 pct, the dollar is unlikely to lose its interest rate and yield advantage any time soon.
Surprisingly weak euro zone inflation data and UK economic data last week poured a bucket of cold water over expectations about when the ECB and Bank of England might raise rates.
Market pricing on the BoE, in particular, was whiplashed. The probability of a rate hike on May 10 stands at just 11 pct now, down from 90 pct late last month. Economists at HSBC say there may be no rate hike at all until 2020.
U.S. economic data, meanwhile, continue to come in reasonably strong, or at least broadly in line with forecasts. The Fed has raised rates six times since December 2015 and markets are pricing in at least two increases this year.
So while the dollar’s rebound has been pretty relentless, the last couple of weeks, it may still have some legs.
“If shorts still have not been squeezed, this dollar rally might have only just gotten started,” reckons Jasper Lawler at London Capital Group.
The opinions expressed here are those of the author, a columnist for Reuters.
Reporting by Jamie McGeever; editing by Larry King