Dollar Bulls Slow the Stampede
Some Investors Pull Back After Worries About Global Growth, Possible Fed Delay in Raising Rates
By James Ramage
Oct. 23, 2014 3:22 p.m. ET
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The crowds of investors piling into the dollar are beginning to thin.
While the dollar has steadied itself after last week suffering its worst selloff this year, some investors said they have become wary of adding to their bullish bets.
For months, an improving U.S. economy and the prospect of higher interest rates sent the dollar soaring against most currencies. Investors placed record bets on a stronger greenback, hoping to get ahead of the torrent of cash expected to flow into U.S. assets once rates begin to rise. Higher rates make a currency more attractive to hold.
But doubts have surfaced this month, which brought a halt to the dollar’s 12-week winning streak, according to the ICE Dollar Index, which measures the dollar against a basket of six currencies. Those doubts intensified last week after worries flared anew about the health of the global economy, sparking a rethink about the strength of the U.S. recovery and raising the prospect that the Federal Reserve would delay any increase in U.S. interest rates. Treasury prices soared, sending yields nose-diving, and stocks plunged.
The prospect of a Fed delay removed, at least temporarily, a key underpinning for the dollar, which lost more than 1% of its value against the euro on Oct. 15. While it has regained some ground, the greenback hasn’t hit its high of just over $1.25 to the euro reached on Oct. 3. It is down 0.1% against the euro and 1.3% against the yen this month.
Late Thursday in New York, the dollar bought ¥108.27, compared with ¥107.15 late Wednesday, and the euro was flat at $1.2647.
Many money managers still see the Fed raising interest rates next year, while other central banks continue to ease monetary policy, and believe the dollar will strengthen in the long run, but are trimming these wagers or buying options as insurance in case the market turns against them.
“Any weakness in the U.S. [economic] data would affect the crowded dollar trade,” particularly against the euro and yen, said James Kwok, head of currencies at Amundi Asset Management, with $1 trillion in assets. “The recent rise of volatility and volume in the [foreign-exchange] market will increase the need for investors to consider hedging their currency risks.”
Amundi is betting the dollar will strengthen against the Canadian dollar and other currencies that would be undermined by falling oil prices. This year, the dollar has gained 5.7% against the Canadian currency.
Bank of America Merrill Lynch on Oct. 17 recommended options that give investors the right to buy Swiss francs, a popular haven, and sell dollars. The bank said the contracts would act as insurance against two risks: that an economic crisis forces the Federal Reserve to abandon plans to raise interest rates or that a widespread Ebola outbreak derails global growth.
Investors and economists overwhelmingly believe the Fed will raise rates sometime next year. That will benefit the dollar by narrowing the differences in yield between dollar-denominated assets and those of higher-yielding currencies, making the greenback more attractive.
At the same time, the European Central Bank and Bank of Japan are attempting to boost inflation and growth by further easing monetary policy, which would weigh on the euro and yen.
“In our view, this is just the beginning; the strong U.S. dollar is here to stay,” wrote Michael Novogratz and Jeff Feig, co-CIO’s of Fortress Macro Fund Ltd., in a letter to investors dated Oct. 15.
But investors aren’t as confident as they once were that central banks will stick to their plans, particularly if slowing economies in Europe or China send global growth into a tailspin.
Predicting the precise moment when the Fed will raise rates is tricky. Weak U.S. data and concerns about low inflation could postpone the Fed’s timeline for raising interest rates. Expectations for a rate increase at the Fed’s July 2015 meeting stood at 27% on Thursday, from 66% in April, according to CME Group Inc.
Because so much money is riding on a stronger dollar, even a small shift in expectations for a rate increase could cause the currency to sell off, some investors said.
“Market positioning worries me, since it could lead to a short-term correction,” said Paresh Upadhyaya, portfolio manager and director of currency strategy at Pioneer Investments, which manages $251.7 billion. “Right now, the conditions may be ripe for this with the fall in U.S. Treasury yields and questions over the start to the tightening cycle.”
Mr. Upadhyaya has positions that will profit if the dollar rises against the euro, pound and Swiss franc.
The fixed-income group at Schroders Investment Management Ltd., which manages $104 billion of the firm’s $464 billion, reduced its bet last week that the euro would fall against the dollar. Bob Jolly, portfolio manager of the Schroder Global Strategic Bond Fund, said investors were becoming too confident that the ECB’s determination to lift inflation would lead to policies that weakened the euro.
“We felt the short-euro position was getting too crowded and some of the world was getting a bit too overexcited for the potential for [euro] devaluation,” Mr. Jolly said.
Additionally, the dollar’s surge is itself becoming a source of worry. A stronger currency gives consumers more spending power by reducing the cost of imported goods, holding down inflation. But it also makes U.S. exports less competitive, threatening a consistent bright spot for the economy. Low inflation is stoking concerns about the sluggish recovery and could give the Fed an excuse to postpone raising interest rates.
Still, dollar bulls said the contrast between the Fed’s plans and moves by the ECB and Bank of Japan to keep borrowing costs low is too great to ignore. And though a winning streak like the dollar saw this summer is rare, the size of the gains is small compared with past rallies. The ICE Dollar Index is up 7% this year, compared with double-digit-percentage gains for four years in a row in the early 1980s or a three-year stretch starting in 1999 that saw the index rise 24%.
Money managers’ net bullish bet on the dollar was running just below an all-time high in the futures market on Oct. 14, according to the most recent data from the Commodity Futures Trading Commission.
“There might be pauses, but no pullbacks,” said Jennifer Vail, who heads fixed-income research at U.S. Bank Wealth Management, which oversees $124 billion. “As we move toward one side easing and another side tightening, that will only amplify the dollar’s strength.” In September, Ms. Vail’s firm bought emerging-market debt denominated in dollars and sold stocks and bonds valued in other currencies.
—Rob Copeland and Chiara Albanese contributed to this article.
While the dollar has steadied itself after last week suffering its worst selloff this year, some investors said they have become wary of adding to their bullish bets.
For months, an improving U.S. economy and the prospect of higher interest rates sent the dollar soaring against most currencies. Investors placed record bets on a stronger greenback, hoping to get ahead of the torrent of cash expected to flow into U.S. assets once rates begin to rise. Higher rates make a currency more attractive to hold.
But doubts have surfaced this month, which brought a halt to the dollar’s 12-week winning streak, according to the ICE Dollar Index, which measures the dollar against a basket of six currencies. Those doubts intensified last week after worries flared anew about the health of the global economy, sparking a rethink about the strength of the U.S. recovery and raising the prospect that the Federal Reserve would delay any increase in U.S. interest rates. Treasury prices soared, sending yields nose-diving, and stocks plunged.
The prospect of a Fed delay removed, at least temporarily, a key underpinning for the dollar, which lost more than 1% of its value against the euro on Oct. 15. While it has regained some ground, the greenback hasn’t hit its high of just over $1.25 to the euro reached on Oct. 3. It is down 0.1% against the euro and 1.3% against the yen this month.
Late Thursday in New York, the dollar bought ¥108.27, compared with ¥107.15 late Wednesday, and the euro was flat at $1.2647.
Many money managers still see the Fed raising interest rates next year, while other central banks continue to ease monetary policy, and believe the dollar will strengthen in the long run, but are trimming these wagers or buying options as insurance in case the market turns against them.
“Any weakness in the U.S. [economic] data would affect the crowded dollar trade,” particularly against the euro and yen, said James Kwok, head of currencies at Amundi Asset Management, with $1 trillion in assets. “The recent rise of volatility and volume in the [foreign-exchange] market will increase the need for investors to consider hedging their currency risks.”
Amundi is betting the dollar will strengthen against the Canadian dollar and other currencies that would be undermined by falling oil prices. This year, the dollar has gained 5.7% against the Canadian currency.
Bank of America Merrill Lynch on Oct. 17 recommended options that give investors the right to buy Swiss francs, a popular haven, and sell dollars. The bank said the contracts would act as insurance against two risks: that an economic crisis forces the Federal Reserve to abandon plans to raise interest rates or that a widespread Ebola outbreak derails global growth.
Investors and economists overwhelmingly believe the Fed will raise rates sometime next year. That will benefit the dollar by narrowing the differences in yield between dollar-denominated assets and those of higher-yielding currencies, making the greenback more attractive.
“In our view, this is just the beginning; the strong U.S. dollar is here to stay,” wrote Michael Novogratz and Jeff Feig, co-CIO’s of Fortress Macro Fund Ltd., in a letter to investors dated Oct. 15.
But investors aren’t as confident as they once were that central banks will stick to their plans, particularly if slowing economies in Europe or China send global growth into a tailspin.
Predicting the precise moment when the Fed will raise rates is tricky. Weak U.S. data and concerns about low inflation could postpone the Fed’s timeline for raising interest rates. Expectations for a rate increase at the Fed’s July 2015 meeting stood at 27% on Thursday, from 66% in April, according to CME Group Inc.
Because so much money is riding on a stronger dollar, even a small shift in expectations for a rate increase could cause the currency to sell off, some investors said.
“Market positioning worries me, since it could lead to a short-term correction,” said Paresh Upadhyaya, portfolio manager and director of currency strategy at Pioneer Investments, which manages $251.7 billion. “Right now, the conditions may be ripe for this with the fall in U.S. Treasury yields and questions over the start to the tightening cycle.”
Mr. Upadhyaya has positions that will profit if the dollar rises against the euro, pound and Swiss franc.
The fixed-income group at Schroders Investment Management Ltd., which manages $104 billion of the firm’s $464 billion, reduced its bet last week that the euro would fall against the dollar. Bob Jolly, portfolio manager of the Schroder Global Strategic Bond Fund, said investors were becoming too confident that the ECB’s determination to lift inflation would lead to policies that weakened the euro.
“We felt the short-euro position was getting too crowded and some of the world was getting a bit too overexcited for the potential for [euro] devaluation,” Mr. Jolly said.
Additionally, the dollar’s surge is itself becoming a source of worry. A stronger currency gives consumers more spending power by reducing the cost of imported goods, holding down inflation. But it also makes U.S. exports less competitive, threatening a consistent bright spot for the economy. Low inflation is stoking concerns about the sluggish recovery and could give the Fed an excuse to postpone raising interest rates.
Still, dollar bulls said the contrast between the Fed’s plans and moves by the ECB and Bank of Japan to keep borrowing costs low is too great to ignore. And though a winning streak like the dollar saw this summer is rare, the size of the gains is small compared with past rallies. The ICE Dollar Index is up 7% this year, compared with double-digit-percentage gains for four years in a row in the early 1980s or a three-year stretch starting in 1999 that saw the index rise 24%.
Money managers’ net bullish bet on the dollar was running just below an all-time high in the futures market on Oct. 14, according to the most recent data from the Commodity Futures Trading Commission.
“There might be pauses, but no pullbacks,” said Jennifer Vail, who heads fixed-income research at U.S. Bank Wealth Management, which oversees $124 billion. “As we move toward one side easing and another side tightening, that will only amplify the dollar’s strength.” In September, Ms. Vail’s firm bought emerging-market debt denominated in dollars and sold stocks and bonds valued in other currencies.
—Rob Copeland and Chiara Albanese contributed to this article.
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