COT update: Elevated dollar and rate bets build as commodity selling eases

SOFR short reaches another record

The leveraged fund short position in SOFR futures reached a fresh record high in the latest reporting week to 30 June, climbing to 3.12 million contracts, equivalent to a notional value of more than USD 750 billion. The short position has more than doubled over the past two months as rising energy prices and firmer inflation expectations prompted a hawkish shift in Fed expectations following the recent FOMC meeting. The latest positioning data shows leveraged funds have become increasingly aligned behind the higher-for-longer interest-rate narrative but also with positioning now at a record extreme, how the market may become more vulnerable to a short-covering reversal should the recent decline in energy prices contribute to easing inflation expectations and reduce the perceived need for further monetary tightening.

SOFR, or the Secured Overnight Financing Rate, is the benchmark rate reflecting the cost of borrowing cash overnight using US Treasuries as collateral. Because SOFR futures prices move inversely to expected short-term interest rates, a short position effectively represents a view that policy rates and funding costs will remain higher for longer or move even higher than currently anticipated.

Commodity liquidation begins to ease

In commodities, another week of weakness, albeit at a slower pace than previously, saw the Bloomberg Commodity Index decline 1%. Broad losses across the major sectors, led by precious metals and energy, were partly offset by a surging softs sector, where cocoa, coffee and sugar rallied strongly.

As mentioned, the reporting week ended ahead of Kevin Warsh’s comments on cooling inflation and Friday’s weak US jobs report, while grain traders only partly had time to respond to the broadly bullish USDA stocks and acreage reports. The latter helped arrest a month-long slide that had seen speculators rush to exit long positions.

Overall, these developments, particularly across grains and softs, helped reduce the one-sided focus on long liquidation that had pressured commodities during previous weeks. In energy, the crude long continued to deflate, not least in Brent, where managed money accounts cut the net long by 38% to a near-historic low of just 55.6k contracts, down around 87% from a March peak of 429k. With the gross short hovering near an all-time high, the long-short ratio has slumped to just 1.2 longs per short, also near a historic low. Such extremes have in the past proved unsustainable, triggering sharp bursts of position adjustment.

In precious metals, investors continued to buy into price weakness, potentially signalling emerging bottom-fishing on expectations that the capitulation phase is giving way to consolidation. Copper, meanwhile, saw selling extend into a fourth week, during which the net long has fallen 20% from a five-year high.

In agriculture, the focus was the bullish price response in wheat and corn following the USDA’s Quarterly Stocks and Planted Acreage reports, forcing hedge funds to cover recently established short positions. Renewed El Niño weather concerns also lifted soft commodities. Cocoa and Arabica coffee have rallied strongly from last month’s lows, supported by adverse weather, tightening physical supplies and renewed concerns about production in the months ahead. These developments triggered short covering in cocoa, while the coffee net long jumped 52%.

The rally accelerated on Monday, with Arabica coffee futures surging as much as 19%, the steepest one-day rise in 26 years. Expectations of a bumper crop in top producer Brazil are being tempered by poor weather that has delayed harvesting, prompting some growers to hold back sales in anticipation of higher prices. Cocoa futures, meanwhile, jumped 13% on Monday to their highest since January as persistent rains across key West African growing regions added to supply concerns, squeezing funds holding sizeable short positions.

What is the Commitments of Traders report?

The COT reports are issued by the U.S. Commodity Futures Trading Commission (CFTC) and the ICE Exchange Europe for Brent crude oil and gas oil. They are released every Friday after the U.S. close with data from the week ending the previous Tuesday. They break down the open interest in futures markets into different groups of users depending on the asset class.

Commodities: Producer/Merchant/Processor/User, Swap dealers, Managed Money and other
Financials: Dealer/Intermediary; Asset Manager/Institutional; Leveraged Funds and other
Forex: A broad breakdown between commercial and non-commercial (speculators)

The main reasons why we focus primarily on the behavior of speculators, such as hedge funds and trend-following CTA's are:

• They are likely to have tight stops and no underlying exposure that is being hedged
• This makes them most reactive to changes in fundamental or technical price developments
• It provides views about major trends but also helps to decipher when a reversal is looming

Do note that this group tends to anticipate, accelerate, and amplify price changes that have been set in motion by fundamentals. Being followers of momentum, this strategy often sees this group of traders buy into strength and sell into weakness, meaning that they are often found holding the biggest long near the peak of a cycle or the biggest short position ahead of a through in the market.