Large speculators just hit their highest total positions on the euro since late 2016
The following is a reprint of the market commentary from the July 2019 edition of The Option Advisor, published on June 28. For more information, or to subscribe to The Option Advisor -- featuring 10 new option trades each month -- visit our online store.
It seems too early yet to gauge the full and complete impact on markets of the June 18 rate-cut insinuations from European Central Bank (ECB) President Mario Draghi, but the immediate impact was described thusly by President Donald Trump on his Twitter account: "Mario Draghi just announced more stimulus could come, which immediately dropped the Euro against the Dollar, making it unfairly easier for them to compete against the USA." (In a June 26 Fox Business interview, Trump went on to tell Maria Bartiromo that "we should have Draghi instead of our Fed person" -- so there are presumably no hard feelings on the matter, aside from the now-perpetual financial media speculation regarding those of the aforementioned "Fed person.")
But the Invesco CurrencyShares Euro Trust (NYSEARCA:FXE) -- which tracks the euro/U.S. dollar exchange rate, and which has already declined more than 10% from its early 2018 highs -- has more or less shrugged off the news, even as some investors appear to be bracing for an extended slide in the common currency.
The same day that Draghi hinted at a possible eurozone rate cut (unfairly or not, depending upon your portfolio allocation), FXE sank to a new low for the month of June -- the lowest intraday level since its June 3 opening bull gap, in fact. But since that immediate post-Draghi slide in shares of the exchange-traded fund (ETF), FXE has snapped back quickly -- and even taken out resistance at its 160-day moving average in the process, which it's now re-testing as support. (For longer-term chart watchers, this daily trendline roughly corresponds with the 32-week moving average.)
Still overhead, though, is the 200-day moving average around $108.48 -- and that's right in the vicinity of $108.42, which marks an exact 10% correction from the February 2018 high close at $120.47. Also in FXE's path higher is the $109.50 neighborhood, which is home to not only the year-to-date breakeven level of $109.48 but also $109.45, which is a 23.6% Fibonacci retracement of the ETF's long-term decline from its Feb. 1, 2018 high close at $120.47 to its May 29, 2019 low close at $106.05.
On a year-to-date basis, etf.com reports net outflows of $87.33 million for FXE -- an amount that nearly offsets the cumulative net inflows of $65.95 million and $13.54 million collected in calendar years 2018 and 2017, respectively. And drilling down, $32.04 million in net outflows -- or 36.7% of the 2019 total -- has been drained out of FXE just in the week or so since Draghi's June 18 remarks.
Given that FXE shares have rallied in the face of these outflows, it's interesting to note that we're coming up on what happens to be one of the better months of the year for the currency tracker, from a seasonality perspective. The ETF averages a return of 0.71% for July, placing the calendar period behind only April (1.07%) and June (0.74%) in terms of monthly performance. That's based on the last 10 years' worth of data, during which FXE has ended July higher on six occasions.
But no doubt the more compelling seasonality quirk (while we're on the subject of arbitrary calendar-based endpoints) is the massive performance gulf between FXE during the third quarter and FXE during virtually every other calendar quarter of the year. Per the table below (via Schaeffer's Senior Quantitative Analyst Rocky White), the euro/USD tracker has averaged a return of 0.91% during the third quarter over the last 10 years -- making this the only calendar quarter during which FXE has managed to produce a positive average return (with 70% of those positive -- again, leading the field). Likewise, the median third-quarter return is 1.26%, which more than doubles the first quarter's "second best" median return of 0.58%.
Sticking with the topic of quirky data points, we arrive at large speculators' euro exposure, as tracked by the weekly Commitments of Traders (CoT) reports. This group has maintained net positioning largely in sync with the price action of the euro of late; a multi-year high net long position (around 147,318 contracts) began unwinding in the early months of 2018, and didn't reach a two-year net short extreme (-111,509 contracts) until April 2019. That long slide from net long to net short tracks closely with the aforementioned decline in FXE over that same time period.
Looking at large speculators' total positions on the euro, though -- which we might consider as a measure of general investor "enthusiasm" toward the currency -- note, per the chart below, that the number of contracts just recently surpassed the early fourth-quarter 2016 peak. While these "total exposure climaxes" haven't necessarily heralded predictable euro moves in one specific direction, the chart patterns suggest that they do frequently "rhyme" with short-term pivot points for the currency.
Back in 2016, the CoT data shows a high in total positions of 405,360 contracts achieved as of the Oct. 25 report. That coincided with a short-term peak of 1.11 for the euro, which then proceeded to lose 6.3% of its value over the next nine weeks as total large speculator exposure deflated by 22.42%.
As of this writing, total large speculator positions on the euro have declined by 9.7% from their May 7 peak at 416,809 contracts so far, while the currency itself has edged up just 0.9% -- suggesting a possible "unwind" scenario could still be in the early innings. And the most recent CoT reports indicate that large speculators are rapidly covering their net short position on the euro -- so if we assume that this group maintains their role as the "smart money," it could bode well for a continued thrust higher in FXE.
That said, given the cluster of overhead resistance levels we called out for FXE earlier in this same commentary (including no less formidable a moving average than its 200-day), as well as the very particular risks inherent to trading a currency-based ETF, we refer prospective FXE players to the advice of Schaeffer's Senior V.P. of Research Todd Salamone, who wrote in his latest Monday Morning Outlook: "There is really no edge to predict what the next tweet or remark might be, or what the outcome of the Trump-Xi meeting will be, which is even more reason to use options to manage risk."
With this in mind, potential premium buyers will be pleased to observe that implied volatility (IV) levels are remarkably low on FXE, as Schaeffer's Quantitative Analyst Chris Prybal observes. Schaeffer's Volatility Index (SVI) is hovering right around 6% as of this writing, which arrives in the 30th percentile of its annual range. Likewise, Trade-Alert pegged the ETF's 30-day at-the-money IV at 5.7% in early trading on June 27 -- in the low 23rd annual percentile, and not far removed from the 52-week low of 4.5%.