Bank of America Merrill Lynch in its currency strategy report feels despite continuous profit taking, selective buying could soon emerge as investors remain in risk on mode.

EPFR Data risk on

Athanasios Vamvakidis and the team at BofA Merrill Lynch feel investors don’t want to spoil the party. Investors resorted to booking profit to protect good average returns gained so far this year.

Risk on mode: USD against GBP and AUD:

The BAML analysts in their liquid cross border flows report said that the FX flows point towards further weakness in USD, particularly against GBP and AUD as risk on continues.

BofAML analysts feel the recent unwinding of GBP and AUD short positions from the possible stretched levels indicate some upside potential for both  currencies in the very short term. The weekly BofAML proprietary FX data flow also reinforces this view, with hedge funds buying both currencies and real money buying GBP for the second week.

However, analysts caution investors to adopt a tactical approach on such trades. Though BofAML’s quant models are long in GBP, they remain short in AUD, as the Australian Dollar is also vulnerable to weak recent data emerging from China. Their report indicates that technical analysis supports the view that the cable remains on a long-term bear trend.

Turning to JPY, Athanasios Vamvakidis and team report FX data flow suggests hedge funds have stopped cutting shorts in Japanese Yen and hence the analysts feel the USD/JPY correction has almost been over. However, BofAML analysts prefer to wait for further clarity before suggesting a long position in USD/JPY.

EPFR data on country flows combine the respective fund flow and country weightings data to track the flow of money into world stock and bond markets. According to BofAML analysts, EPFR data indicate strong flows almost across the board, especially from bond positions and emerging markets. The following table depicts EPFR 1-week fund flows as a percentage of AUM:

However BofAML’s own flows suggest accelerated selling of EMEA and LatAm currencies so its not risk on there. The following snapshot of flows throws light on BofAML’s weekly proprietary FX flows (Z-Score):

BofAML Z Score

BofAML analysts feel though the Dollar Index Spot Exchange Rate (DXY) posted a 2 percent fall last week, both BofAML’s flows and the CFTC data continue to suggest that long USD positioning may be stretched. Further, BofAML’s total proprietary USD flows displayed a flat trend last week.

The analysts feel the accelerating USD selling by hedge funds and decelerating USD buying by real money reinforces their last report’s warning for rising risk of retracement in USD buying. Their view is further strengthened with last week’s US payroll data suggesting inconclusive evidence about the prospects for early tapering of FED QE.

BofAML analysts, however, believe that last week’s events have not substantially changed the market consensus. This, in the analysts’ view, would in turn limit any likely correction in USD positions.