Technically Speaking: COT Positioning – Risk Of Correction Still High (Q1-2020)

Much of the bulls rallying cry has been based on the dollar weakening with the onset of QE, but as shown above, that has yet to be the case. However, it is worth noting that positioning in the US Dollar has been weakening. Historically, these reversals are markets of more important peaks in the market and subsequent corrections. 

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It is also worth watching the net-short positioning the Euro-dollar as well. Historically, when positioning in the Eurodollar becomes NET-LONG, as it is currently, such has been associated with short- to intermediate corrections in the markets, including outright bear markets.

Net-long Eurodollar positioning has recently started to reverse from an all-time record. While the market hasn’t corrected as of yet, if foreign banks begin to extract dollar-denominated assets to a large degree, the risk to the market rises sharply. 

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Interest Rate Extreme

One of the biggest conundrums for the financial market “experts” is why interest rates fail to rise. In March of last year, I wrote “The Bond Bull Market” which was a follow up to our earlier call for a sharp drop in rates as the economy slowed. That call was based on the extreme “net-short positioning” in bonds which suggested a counter-trend rally was likely.

Since then, rates fell back to some of the lowest levels in 10-years as economic growth continues to slow, both domestically and globally. Importantly, while the Federal Reserve turned back on the “liquidity pumps” last October, juicing markets to all-time highs, bonds have continued to attract money for “safety” over “risk.” 

Not surprisingly, despite much commentary to the contrary, the number of contracts “net-short” the 10-year Treasury remains at some of the highest historical readings.

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Importantly, even while the “net-short” positioning on bonds has been reversed, rates have failed to rise correspondingly. The reason for this is due to the near-record levels of Eurodollar positioning, as noted above.

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This suggests a high probability rates will fall further in the months ahead. This will most likely occur in concert with further deterioration in economic growth as the impact of the “coronavirus” is realized. 

Amazingly, investors seem to be residing in a world without any perceived risks and a strong belief that financial markets can only rise further. The arguments supporting those beliefs are based on comparisons to previous peak market cycles. Unfortunately, investors tend to be wrong at market peaks and bottoms.

The inherent problem with much of the mainstream analysis is that it assumes everything remains status quo. However, such never tends to be the case for long.  

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