2021: rising uncertainty, higher US Dollar

In the past few weeks, we have noticed that the ‘Short Dollar Trade’ has remained very crowded despite the positive bounce in the USD in January. According to the CFTC, total amount of net shorts is still standing at 257K contracts, a short USD position that is mainly concentrated against the Euro (165K contracts). Even though some investors argue that the CFTC CoT only shows a minor picture of the daily 5-trillion USD OTC FX market, it is still interesting to know the dynamics in the standardized market, especially when the positioning are standing at extreme levels.

Figure 1

Source: CFTC

We think that the rise of uncertainty in 2021 amid elevated restrictions and travel bans between ‘high-risk’ countries may increase demand for traditional safe such as the greenback and that the lack of economic activity in the Euro area could lead to a rise in political uncertainty, which should weigh on the single currency in the near to medium term. Figure 2 (right frame) shows that rising uncertainty has historically led to a higher Dollar against most currencies.

Figure 2

Source: Eikon Reuters, Baker et al. (2016)

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