Commodities crash, dollar soars in sharp reversal of recent trends

Tom Tong09/May/2011Currency Updates

The extreme positioning in the two most favoured trades of the year (short the dollar, long commodities) finally snapped last week. Traders scrambled to cover their positions. The weakness was initially blamed on a variety of factors, such as Chinese central bank hawkishness and weak macroeconomic numbers out of the US, UK and Europe. The sell-off accelerated on Thursday, as ECB president Trichet sounded less hawkish than the market had been expecting. The resulting weakness in the euro currency quickly spilled over to commodity markets, as margin calls went out and positions were liquidated with a violence not seen since the worst days of the 2008-2009 crash. By contrast, markets where positioning had been far less extreme, like bonds and equities, had more subdued moves, though equities did end the week down significantly as bonds rallied.


Another raft of disappointing macroeconomic data hit sterling last week. Services and manufacturing sentiment numbers both came in lower than expected, signalling that the combination of a slowdown in consumer confidence and drastic public austerity is starting to impact business decision makers. The Bank of England met, and as expected left both rates and the size of its balance sheet unchanged; as is customary when no changes are implemented, there was no statement either, so the meeting had very little impact on markets.

Sterling lost ground against the dollar – not surprising, given the generalized rebound in the greenback. However, the real action was against the euro. GBP first lost over 2% against the common currency, only to take that back and then some as first, the relatively dovish ECB took the wind out of the euro, and on Friday, a report in a German newspaper that the Greek government was considering exiting the common currency knocked it for a loop. Sterling ended the week up over 1% against the EUR, and the trading range between the two largest European currencies was the widest it has been for months.


EUR’s ability to rise week after week, in the face of deteriorating news and sentiment on the peripheral economies had earned it the moniker “Teflon euro” around some trading floors. No more. The common currency sold off harder and faster than any other major currency last week. The continuous pile up of euro-negative developments last week included the generalized position squaring among traders shorting the US dollar; weaker than expected macroeconomic news not only out of the periphery, but the core as well; a relatively dovish ECB conference, where Trichet failed to use the “vigilance” code word that would have announced another hike at the June meeting; and, finally, reports in Der Spiegel (promptly and vigorously denied by all concerned) that Greece was considering exiting the Eurozone. Of all the developments, we think the latest one is the most ominous. It seems likely that Der Spiegel was part of an attempt by certain factions in the German financial establishment who are fed up with the European policy of ignoring reality and hoping that the problems will improve on their own trying to take a more realistic tack in regards to the unsustainability of peripheral debt loads. These last developments bring the peripheral crisis back in full force, and will weight on the euro in the coming weeks. The common currency ended the week at the lows, down over 3% against the greenback.


The greenback finally broke the losing streak it had accumulated for the past few weeks, and it did so in a spectacular fashion. The macroecnomic newsflow out of the United States continues to display a soft tone, while the payroll report came in better than expected, consistent with a market that is finally generating jobs in excess of the natural growth of the labour force. The spike in weekly jobless claims and a nasty drop in the ISM services business sentiment are worrisome; these latter indicators are probably the best high-frequency predictors of US GDP. However, the markets remained focused both on the stretched positioning against the dollar and long commodities and the fact that the incremental news flow is relatively worse in other developed markets. The USD gained a very significant 1.4% in trade-weighted terms, and for those who care about that sort of thing, lots of damage has been done in technical charts to the “short-the-dollar” heretofore one-way bet.


Written by Tom Tong
