Is it a rally, or is it short covering?

FT Alphaville

Exhibit a) the euro versus the dollar:

How does one account for Tuesday’s sudden (and rather non-news specific) reversal in the euro?

Here are the thoughts of Michael Derks, chief strategist at FX Pro:

On three occasions since the start of last week there have been powerful short-covering rallies in the single currency which have imposed pain and suffering on all of those record short positions amongst the trading community. This morning’s jump from a low of 1.2650 to a high of 1.28 is the latest episode, and once again it is difficult to pinpoint any real trigger for the move. Indeed, the euro is now not that far from where it was trading prior to the commencement of Friday’s S&P credit rating-downgrade rumours. The single currency has managed to recover despite the now distinct likelihood that Greece will default before too long as well as the scathing criticism of a draft of the fiscal compact from an ECB board member. Euro shorts will be taking note of the inability of the single currency to sustain sell-offs on bad news.

The record short positions he’s referring to, meanwhile, are these (collated from the net positions of traders in CME foreign-exchange futures):

(Chart courtesy of Monument Securities.)

On to exhibit b) the S&P 500:

This time, Chris Verrone, at Strategas Research Partners makes the following point (his emphasis):

With the S&P 500 up 13 out of the last 17 days and still challenging the 1290-1310 resistance range, it’s worth noting that NYSE short interest is back to its lowest level since 1Q 2011. The short covering phase of this rally is likely exhausted. As we highlighted in Thursday’s note, the package of sentiment data suggests that investor complacency is growing – just 17% of respondents in the AAII retail survey are bearish (the lowest reading in close to seven years), and the Economic Surprise Indicator suggests the bar is high for additional upside surprises out of the U.S. economic data.

The respective short-interest chart, meanwhile, looks like this:

So we’ll ask once again, are these rallies driven by fundamentals, or just short covering?

If it’s the latter, the S&P 500 case certainly sets an interesting precedent.


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