DB FX Daily: Short USD and Long GBP Positions Build, Flows to Gilts Slow

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FX Daily: Short USD and Long GBP Positions Build, Flows to Gilts Slow

Long GBP, Short USD Positions Build During Ranging Market

Our latest DB FX Positioning Indices updated with data through yesterday's close show continued appetite to add to short USD positions in the first three days of this week with GBP longs and EUR longs building. The latest numbers compared with the last update released on Monday are shown in the chart at left below. The increase in GBP longs is perhaps of some concern as according to our positioning indices it has taken place while GBP/USD has traded in a narrow 1.9580-1.9720 range this week. Though USD short positions have yet to reach "extreme" levels beyond -7 on our index, the recent increase in short USD positions has occurred while the USD index has traded sideways over the past week. In summary while short USD and long GBP positions have yet to reach extreme levels that would point to a higher probability of mean reversion, the recent accumulation of risk during ranging markets may present some short-term vulnerabilities. While the risk of a USD correction exists should the steady diet of negative US data surprises be interrupted, we continue to see the scope of any correction as quite limited given the still negative USD environment presented by narrowing real rate spreads driven by weak activity data, building inflation concerns and a steepening US yield curve (see yesterday's FX Daily). For GBP however, if we were to see negative data surprises with the money markets still pricing some probability of a 25 bp rate increase in April or another dip in risk appetite the potential for correction could be higher. In other currencies, there has been little sign of reduction in long AUD positions but a small shift to long JPY following yesterday's JPY rally against many currencies including the high yielders.

Foreign Gilt Purchases Fell Back in Q1 Following Oil Correction in H2 2006

Earlier this week we looked at oil correlations with G10 FX and found that GBP/USD had seen the most rapid increase in correlation with oil over the past few years. We believe much of this has been driven by increased reserve building by oil exporters who may have larger allocations to GBP. The close relationship between crude oil prices and gilt purchases would support this view. The chart at right below shows the latest data on foreign gilt purchases and records a substantial slowdown to start 2007 as oil prices sagged in 2006. But going forward a renewed rally in crude prices could once again provide capital flows to support GBP though currently the once strong inflows appear to have abated in Q1 of 2007.