This Rare Currency Signal Has Been Bullish for the Buck

Large speculators were short the dollar for the longest stretch in 6 years

Nov 16, 2017 at 10:38 AM
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The U.S. dollar got hammered in the first nine months of 2017, but has rebounded off its September lows, as evidenced by the price action in the U.S. Dollar Index (DXY). As such, large speculators are finally net long the greenback for the first time in 15 weeks, per recent Commitment of Traders (CoT) data, breaking the longest stretch in six years. Below, we'll take a look at how the buck and the stock market tend to perform after these rare currency sentiment signals.

The DXY has added about 3% since touching a nearly three-year low of $91.01 on Sept. 8, but remains well off its Jan. 3 post-financial crisis peak of $103.82. The exchange-traded fund (ETF) shares are now testing a 23.6% Fibonacci retracement of their decline from January to September, in the $93.84 area. This area stifled DXY's rebound attempts in July, August, and October.

dollar index chart

As alluded to earlier, in light of the dollar's recent bounce, large speculators have turned long after 15 weeks of being short the buck. That marks the longest stretch of net short positions on the dollar since May 2011, and prior to that you'd have to go back to 2009, where these speculators were net short the dollar for 26 straight weeks. The longest-ever streak of net short positions ended in 2005, after 44 weeks, according to data from CoT and Schaeffer's Quantitative Analyst Chris Prybal.

spx and CoT dollar signal

streak of CoT net short dollar

There have been just 13 times when net short positions on the U.S. dollar went at least 15 weeks. These signals have been bullish for the buck, historically. In fact, the dollar enjoyed much bigger-than-usual average returns one to six months after a signal, and generated a higher-than-average win rate, compared to anytime data since 1992.

dollar after CoT signal

However, a shift back to long dollar positions after a lengthy stretch of net short positions tends to precede stock market weakness. After these signals, the S&P was in the red at every single checkpoint up to six months out, compared to anytime gains since 1992. What's more, the SPX was higher just 25% of the time two weeks and a month after a signal, compared to a win rate of 59% and 63% anytime, respectively.

spx after CoT dollar signals

In conclusion, while the historic data doesn't bode well for the S&P 500, the stock market's short-to-intermediate-term price action will likely depend on the course of tax reform in the U.S., as well as the Fed's rate decision and changing of the proverbial guard, among other things. And, of course, there's always the unknown. But while the aforementioned data may strike a cautious tone, it's encouraging that we haven't yet hit the euphoria phase of the sentiment cycle that coincides with market tops, suggesting there's plenty of room for more buyers to jump in on the rally.

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