By Saqib Iqbal Ahmed
NEW YORK (RockedBuzz via Reuters) – The strong US economy is giving the dollar an unexpected boost, frustrating bearish investors who are betting on its decline.
The dollar is up 2.5% from its recent low against a basket of currencies and is nearing its highest level since March.
The nascent rally defied expectations that the currency would resume falling from last year’s multi-year highs: Net futures bets against the dollar settled at $12.34 billion in the week to May 30, after hitting a low two-year to the beginning of the month, according to data from the Commodity Futures Trading Commission. Fund managers named dollar shorting as the third “busiest” trade in the market in the latest BofA Global Research survey.
The dollar is “in a very messy transition from a bull market to a bear market,” said Aaron Hurd, senior portfolio manager, currency, at State Street Global Advisors. “That transitional period is going to be quite frustrating.”
Hurd expects the dollar to remain buoyant in the very short term, but to decline steadily over the next few years.
Bears say the dollar has plenty of room to fall as the currency remains about 15% above its post-pandemic low and the Federal Reserve is expected to soon end the interest rate hikes that helped to support the greenback.
But the bears’ view has been hampered by a string of strong US data suggesting the economy remains resilient despite a flurry of Fed hikes aimed at slowing growth and containing inflation. Most investors believe the dollar will likely remain elevated until US data becomes significantly weaker, allowing the Fed to cut rates.
The latest test of the economy’s strength came on Friday, as the US posted better-than-expected job gains for May. Other recent data points, including consumer spending and new home sales, also weighed against the view that the Fed will cut rates soon.
Traders were betting on Friday that the federal funds rate – which currently sits between 5% and 5.25% – would end 2023 at 4.988%, versus early May expectations to end the year at 4.188%. Higher rates tend to increase the attractiveness of the dollar.
“The dollar’s strength is entirely related to the fact that the US data is actually pretty good,” said Alvise Marino, a strategist at Credit Suisse.
Credit Suisse strategists recently bet on the dollar gaining against the euro, according to a note. The greenback was up about 3% against the euro in May.
A stronger dollar may represent a headwind for risky assets as it helps tighten credit conditions weighing on the profits of US exporters and multinationals.
Another potentially complicating factor for dollar bears is a surge in US treasury issuance expected over the rest of the year, with the US Treasury expected to start filling its coffers now that the debt limit has been lifted. .
One view argues that such a large amount of Treasuries will drain liquidity from the market, potentially creating demand for dollars, said Bipan Rai, head of FX strategy for North America at CIBC.
However, many believe it is only a matter of time before the dollar resumes a downtrend that has seen it lose as much as 11.5% from its highs in September.
UBS Global Wealth Management ranks the dollar as its “least preferred” currency, saying the Fed is likely to cut rates later this year or early 2024, narrowing its yield advantage over the euro and to other currencies.
Federal Reserve officials indicated last week that the central bank would likely skip an interest rate hike at its next meeting on June 13-14, leaving the door open to a future increase in borrowing costs. In Europe, European Central Bank (ECB) President Christine Lagarde said further policy tightening was needed, a trend that would undermine the dollar’s yield advantage.
“Once the Fed stops rallying, the market will focus more on timing the first rate cut and that will likely weaken the dollar,” said Brian Rose, senior economist at UBS Global Wealth Management.
CIBC’s Rai believes the dollar’s continued strength will give way to weakness as it becomes clearer later this year that the Fed will stay away from further rate hikes while the ECB may have more work to do.
“From a macro perspective, I still believe the dollar needs to decline,” he said. “But that story may have to wait until the second half of this year.”
(Reporting by Saqib Iqbal Ahmed; Editing by Ira Iosebashvili and Leslie Adler)