EUR/USD: a contrarian signal suggests the pursued climb of the USD

The strength of the US dollar is expected to continue, as suggested by the short commercial hedgers on the dollar index futures (DXY). Whenever the commercial hedgers are net bearish and in the bottom tenth percentile of historical readings, this is a contrarian indicator of continued US dollar strength.

The dollar index (DXY) is trending upwards in 2021, having ended the previous year at low levels. Perhaps the best example of the dollar's recovery comes from the EUR/USD exchange rate, which has fallen significantly from its opening levels at the beginning of the year to the current 1.16 area.

The euro is an important component of the DXY, accounting for more than half of the index's weight. As such, the two are closely correlated.

When a market falls significantly, as the EUR/USD did in 2021, traders are tempted to buy it. Any bounce suddenly looks like a bottom, and contrarian traders continue to look for reversal patterns, such as descending bevels, bullish engulfments or inverted heads and shoulders.

But the EUR/USD continues to fall and the DXY to rise. The trend is likely to continue, at least judging by the positioning of commercial hedgers.

What is a commercial hedger?

Commercial hedgers are companies that take positions in the futures market, and they usually operate in the commodity markets. For example, a commercial hedger may buy futures contracts to secure the price of a commodity it will need at a later date.

But commercial hedgers also operate in the currency market. Their short exposure to DXY has reached extreme levels. In the past, this was a contrarian signal. Specifically, the US dollar rally has continued rather than dissipated.

Ahead of today's Non-Farm Payrolls release, EUR/USD remains under pressure judging by the positioning of commercial hedgers. If we see a decent jobs report, we would also expect the USD to make a further jump forward.