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Speculators Flock to Short Side of the USD

The new year commenced with futures speculators short the euro and the pound.  And why not with the uncertainty looming about the pending debt auctions in some of the weaker euro members.  Then, after a couple of rigged auctions, with the ECB and some of their appointees buying ample quantities of the dubious quality debt, the concern abated.   Spain, then withdrew bonds sales, instead choosing private bank placements, leaving the market with the impression the euro problem was solved.

The apparent solution to the debt problem came at a very inopportune time for the speculators, who were short 49,870 contracts according to the  01 11 2011 COT report. This resulted in a short squeeze, and quickly the market rallies from under 1.29 to above 1.36.  The large specs, which includes a variety of funds, then made an aggressive move from the short to the long side of the euro.  In the period ending 01 18 2011, they reduced their shorts by almost 25k contracts, and increased longs by 23k.  This is a massive weekly shift.  You wonder how much of the market strength was the result of news and short covering, and how much the result of trend followers going with the flow of the market.  The decline in the OI suggests there was very big short covering.

When the curtain dropped at the end of the period the large spec had accumulated a 25k long, but this is only a net 2.3% of the total OI, not an excessive commitment.  This implies the big specs have room to buy more euro contracts.

Equally interesting is the behavior of the small specs.  They were euro buyers, but were not aggressive enough to cover their short.  As the market has worked higher since Jan 18, this has probably resulted in short covering, but this does not preclude more buying from the trend followers.

The specs were quicker to exit their short positions in the pound.  At the beginning of the year, large and small specs were short over 20k contracts on the pound.  By the last report, they were over 7k long.  Last week the small and large specs both flipped their positions to the long side of the pound.  As the specs moved to the long side, the pound has rallied from below 1.54 to above the 1.60 handle.  Unlike the euro the OI in the pound went up last week as new longs entered the market.

Part of the pound's run up has been caused by fear the current inflation rate, again over the BOE's  target, will hasten the day when English bank rates increase.  Tomorrow we get the preliminary q/q GDP in Britain.  If the projected increase is as projected, a paltry 0.5%, then we think talk about a UK rate increase will abate.

There are numerous other important reports this week including the FOMC statement. We will see how they unfold, and they should give us a week of volatility.  On Friday we do get the advance US GDP report,  projected to be a 3.5% increase.  With the US growth rate exceeding Britons by a full 3.0%, we think that the 1.60 level will be difficult for the pound bulls to defend.  Should the pound bulls take the GBP/USD above the 1.60 level we want to try the short side of that pair, with an appropriate money management stop.  Should the market falter, a return to the 1.5650/1.57 level is possible.