USD forecast: Positioning hints at headwinds for USD, 2-year yield

Expectations for Fed policy and therefore the movement of bond yields continue to be a main driver of sentiment for global markets. Sure, other things are happening in the world but, for now at least, it’s the theme markets always revert to when given half a chance.

Market pricing is less confident of several Fed cuts this year, yet still they’re trying to price them in. Fed fund futures currently imply that the Fed’s target range will remain at 5.25% - 5.50% over the next two meetings, with a 51.8% chance of their first cut in June with odds of subsequent cuts quickly diminishing below 50% further out. But you can bet that they’ll quickly reprice multiple cuts if economic data for the US turns south.

But what I am looking at today is market positioning of the 2-year bond note from the weekly COT report, as it can help decipher where these futures traders see yields in the future. The 2-year note is used as the 2-year yield is widely used as a gauge for Fed policy expectations.

US 2-year note, large speculator positioning form the COT report:

Net-short exposure to the 2-year note has diminished to a 24-week low, yet still remains stretched by historical standards
Short bets have been reduced by -17.4% since its peak in November, gross long exposure remains subdued
If net-short exposure continues to diminish, it suggests yields could drop
In 2023 the 2-year yield flatlined above 5% despite net-short exposure rising aggressively into its record high – what’s the say yields should simply surge to new this this time around, if short-interest is diminishing?

As this is a weekly chart it smooths out the day-to-day headlines. And a clear trend to my eyes is that net-short exposure among large speculators is diminishing, due to a culling of short bets. And despite the -17.4% drop in shorts since the November peak, it could still be argued that bearish positioning remains stretched; it’s record high of net-short exposure was over six standard deviations from the mean (-6SD), and even with net-short exposure at a near 6-month low, bearish positioning remains ~5SD from the mean. In a nutshell, bears may still be too bearish considering the Fed are most likely done within hiking interest rates, and the latest upswing in might be capped to below the 2023 peak.

US dollar index, US 2-year yield technical analysis:

With US economic data remaining firm overall, there’s nothing to say that the 2-year yield cannot rise further from her. Yet I now remain doubtful that it will break above the 2023 highs. RSI (2) is overbought on the weekly chart, so I am now looking for evidence of a swing high on the 2-year yield. And whilst this correlation with the US2yr and US dollar index is not as pristine as it was in 2022, lower yields could surely weigh on the US dollar index at least to a degree.

But to become convincingly bullish the 2-year note (which should be bearish for the 2-year yield and US dollar), the wheels likely need to fall off of the economy sooner than later to enable multiple Fed cuts to be re-priced. As I remain sceptical of that, the bias is for a retracement on the US dollar once yields have completed their current rebound, but for the US dollar index to hold above the December low. From there, price action could be choppy for both markets as markets try to decipher the Fed’s actions in H2.

-- Written by Matt Simpson

Follow Matt on Twitter @cLeverEdge

How to trade with City Index

You can trade with City Index by following these four easy steps:

Open an account, or log in if you’re already a customer

• Open an account in the UK
• Open an account in Australia
• Open an account in Singapore
Search for the market you want to trade in our award-winning platform
Choose your position and size, and your stop and limit levels
Place the trade

This report is intended for general circulation only. It should not be construed as a recommendation, or an offer (or solicitation of an offer) to buy or sell any financial products. The information provided does not take into account your specific investment objectives, financial situation or particular needs. Before you act on any recommendation that may be contained in this report, independent advice ought to be sought from a financial adviser regarding the suitability of the investment product, taking into account your specific investment objectives, financial situation or particular needs.

StoneX Financial Pte. Ltd., may distribute reports produced by its respective foreign entities or affiliates within the StoneX group of companies or third parties pursuant to an arrangement under Regulation 32C of the Financial Advisers Regulations. Where the report is distributed to a person in Singapore who is not an accredited investor, expert investor or an institutional investor (as defined in the Securities Futures Act), StoneX Financial Pte. Ltd. accepts legal responsibility to such persons for the contents of the report only to the extent required by law. Singapore recipients should contact StoneX Financial Pte. Ltd. at 6826 9988 for matters arising from, or in connection with the report.

In the case of all other recipients of this report, to the extent permitted by applicable laws and regulations neither StoneX Financial Pte. Ltd. nor its associated companies will be responsible or liable for any loss or damage incurred arising out of, or in connection with, any use of the information contained in this report and all such liability is hereby expressly disclaimed. No representation or warranty is made, express or implied, that the content of this report is complete or accurate.

StoneX Financial Pte. Ltd. is not under any obligation to update this report.

Trading CFDs and FX on margin carries a high level of risk that may not be suitable for some investors. Consider your investment objectives, level of experience, financial resources, risk appetite and other relevant circumstances carefully. The possibility exists that you could lose some or all of your investments, including your initial deposits. If in doubt, please seek independent expert advice. Visit www.cityindex.com/en-sg/terms-and-policies for the complete Risk Disclosure Statement.

ALL TRADING INVOLVES RISKS. LOSSES CAN EXCEED DEPOSITS.

City Index is a trading name of StoneX Financial Pte. Ltd. (“SFP”) for the offering of dealing services in Contracts for Differences (“CFD”). SFP holds a Capital Markets Services Licence issued by the Monetary Authority of Singapore for Dealing in Exchange-Traded Derivatives Contracts, Over-the-Counter Derivatives Contracts, and Spot Foreign Exchange Contracts for the Purposes of Leveraged Foreign Exchange Trading. SFP is also both Derivatives Trading and Clearing member of the Singapore Exchange (“SGX”). SFP is a wholly-owned subsidiary of StoneX Group Inc.

The information provided herein is intended for general circulation. It does not take into account the specific investment objectives, financial situation or particular needs of any particular person. You should take into account your specific investment objectives, financial situation or particular needs before making a commitment to invest, including seeking advice from an independent financial adviser regarding the suitability of the investment, under a separate engagement, as you deem fit. No representation or warranty is given as to the accuracy or completeness of this information. Consequently, any person acting on it does so entirely at their own risk.

The information does not represent an offer of, or solicitation for, a transaction in any investment product. Any views and opinions expressed may be changed without an update. To understand the risks and costs involved, please visit the section captioned “Important Information” and the “Risk Disclosure Statement”.

The information herein is not directed to, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in any locality, state, country or other jurisdiction where such distribution, publication, availability or use would be contrary to law or regulation.

StoneX Financial Pte. Ltd. 1 Raffles Place, #18-61, One Raffles Place Tower 2, Singapore 048616. Tel: 6309 1000. Co. Reg. No.: 201130598R.

This advertisement has not been reviewed by the Monetary Authority of Singapore.