views

OVERBOUGHT EURO HAS CAP TO ITS UPSIDE

BORIS SCHLOSSBERG<br /><strong>DIRECTOR OF CURRENCY RESEARCH, GFT</strong><br /><br />ON Friday, the US Commodity Futures Trading Commission (CFTC) released their weekly commitment of traders (COT) report for currency futures. Since the spot currency market is decentralised, there are no reports about positioning data. Therefore, the COT report is the only publicly available piece of data that provides information on market sentiment on futures of the Chicago Mercantile Exchange (CME). <br /><br />The COT is essentially a contrarian indicator. The idea behind the report is that when too many traders skew to one side or another, trading becomes very crowded and prices are vulnerable to reversing. Typically, the weekly positioning data is only of cursory interest to most currency traders, often showing a rough equilibrium between longs and shorts. However, when positioning reaches extremes it can often presage a major turn in the market and savvy currency traders suddenly pay attention to the numbers.<br /><br />The latest news from the COT certainly has raised my eyebrows. The report shows that net long positions in the euro &ndash; by far the most active currency contract on the CME &ndash; have increased to 34,772 from 13,614 the period prior. This is the highest level of euro longs in 52 weeks, indicating that positive sentiment is approaching extreme levels. <br /><br />By now, the recovery trade has become common wisdom, with the majority fully convinced that the second half of 2009 will bring a rebound in economic activity. I have long been sceptical of this consensus view given the still rising rate of unemployment, moribund consumer spending and escalating fiscal problems across the G3 universe. <br /><br />The latest positioning data from the CME only confirms my doubts about the bullish thesis in suggesting that any upside may be limited. Although positioning by itself rarely provides a perfect-timing signal for a turn in price, the CFTC data does indicate caution ahead. When positioning reaches 52-week highs &ndash; as it is doing now &ndash; at least a partial correction is due in the days ahead as the markets work off the overbought sentiment. Therefore, traders should be very wary of chasing price under current conditions and those who are long risk currencies such as euro, sterling or Aussie. Instead, you may want to consider tightening your stops as the danger of reversal in price grows stronger by each day.<br /><br />Boris Schlossberg and Kathy Lien are directors of currency research at GFT. Read their daily commentary on currencies at www.GFTUK.com/commentary or e-mail them at BorisandKathy@gftuk.com.