The $277 Billion Robots Have Dropped Their Dollar Short. For Now

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(Bloomberg) -- For clues on whether the dollar’s uptrend still has juice, look to the robots.

Automated trend-followers, known as commodity trading advisers, have flipped to neutral from a big short position on the greenback in recent weeks, a shift that helped accelerate the currency’s surprise advance. Now they’ve blown through all their stop-losses, and it could spell bad news for bulls from here.

As hedge-fund counterparts continue to bet on declines, CTA exposures are nearly flat on the dollar after they were forced to pare losses across G-10 currencies including the euro, yen, and British pound, quant researchers said. The upshot is that greenback bears are no longer fighting a headwind posed by automated buying from a group with combined assets of some $277 billion.

“Much of the ‘forced buying’ in these crosses has been exhausted,” said Peter Hahn, co-founder of Bridgeton Research Group, a quantitative research firm. “This could result in more subtle influences from their flows than those recently witnessed as they hit stop-outs.”

Wall Street has been caught off guard by the greenback’s gains of late, conjuring a myriad of theories to explain the out-of-consensus move, from America’s growing interest-rate gap with developed peers to easing growth momentum in Europe. Even though the rally has sputtered in the wake of the Federal Reserve meeting, the Bloomberg Dollar Spot Index remains on track for its biggest three-week advance since 2016. The gauge rose 0.2 percent in Friday trading.

Looking for a Trade

Trend-followers take a position across asset classes and, if momentum looks extreme, they will seek to profit from a shift back to the mean. CTA assets have doubled over the past decade, according to BarclayHedge data, to $277 billion at the end of 2017.

Models that seek to re-engineer trading strategies show CTAs have shifted from short positions to effectively neutral on the dollar, according to Bridgeton and Toronto-Dominion Bank.

“The dollar is now a momentum trade with some breaks of the key moving averages and the macro-community looking for a trade,” said Mark McCormick, the North American head of foreign-exchange strategy at Toronto-Dominion Bank.

CTAs acted as the gasoline that helped fuel recent dollar gains, according to Mark Connors, head of risk advisory at Credit Suisse Group AG. “Both global macro and CTAs can push around an FX pair,” he said.

The theory goes that if fast-money investors helped spur outsize gains, not backed by fundamentals, the greenback’s advance could well be on thin ice. But not all hope is extinguished for bulls: CTAs could also lend momentum to an upward move if the greenback manages to break more technical levels.

“Should the strong U.S. dollar trend endure, trend-follower CTAs will, at certain levels, continue buying,” Bridgeton’s Hahn said. “They have enormous aggregate potential buying power up to their maximum deployable long risk.”

Breakouts

The outlook for the currency appears finely balanced, with plenty of ammunition for bulls and bears alike. The greenback looks cheap relative to its interest-rate gap with Germany, with the two-year spread at a record, while lackluster industrial and inflation data this week suggest a slowdown in euro-area growth. Extended bearish bets among hedge funds and other speculators raise the possibility of short covering.

On the other hand, the currency’s relative strength index -- a measure of momentum -- is the most overbought since 2016.

All eyes are now on breakout levels. Bloomberg’s dollar gauge passed its 200-day moving average this week, for the first time since May 2017, while the euro dropped below the same trendline versus the greenback. Similar tests are near for both the pound and yen against the dollar.

“It’s really a question of technicals,” said Thierry Wizman, a global rate and currency strategist at Macquarie Group Ltd. in New York. “CTAs are certainly not long the dollar yet -- what we have seen so far seems more like short-position covering.”

©2018 Bloomberg L.P.

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