Investors who have been anticipating a decline in the dollar are facing frustration as the unexpected strength of the U.S. economy is actually boosting the currency.
Currently, the dollar has experienced a 2.5% rise from its recent low against a range of currencies and is now approaching its highest level since March.
This rally goes against predictions that the currency would continue its downward trend following the multi-decade highs it reached last year. Data provided by the Commodity Futures Trading Commission reveals that in the week ending May 30, net futures bets against the dollar amounted to $12.34 billion, bouncing back from a two-year low earlier in the month.
The latest survey from BofA Global Research has also identified shorting the dollar as the market’s third most popular trade.
According to Aaron Hurd, a senior portfolio manager at State Street Global Advisors, the dollar is going through a messy transition from a bull market to a bear market, which can be frustrating.
Although Hurd anticipates that the dollar will maintain its strength in the immediate future, he foresees a gradual decrease over the course of the next few years.
Bears argue that there is still room for the dollar to fall since it remains approximately 15% above its post-pandemic low.
Additionally, the Federal Reserve is widely expected to end the interest rate increases that have been supporting the dollar.
However, the bearish view has been challenged by strong U.S. economic data, indicating that the economy remains resilient despite the Fed’s efforts to slow growth and contain inflation.
Most investors believe that the dollar will likely stay elevated until U.S. data significantly weakens, providing an opportunity for the Fed to cut rates.
The recent employment gains reported in May, along with other positive data points such as consumer spending and new home sales, have contributed to the dollar’s strength.
Traders are now betting that the fed funds rate, currently ranging between 5% and 5.25%, will end 2023 at 4.988%, compared to the expectations from early May of 4.188%. Higher interest rates tend to enhance the appeal of the dollar.
Alvise Marino, a strategist at Credit Suisse, attributes the strength of the dollar to the fact that U.S. data is actually quite good.
According to recent reports, Credit Suisse strategists have placed their bets on the dollar strengthening in relation to the euro.
As a result, the greenback experienced a 3% increase against the euro during the month of May.
While a stronger dollar can present challenges for risk assets, as it tightens credit conditions and affects the profits of U.S. exporters and multinationals, another complicating factor for dollar bears is the expected flood of U.S. government bond issuance for the remainder of the year. The U.S.
Treasury is anticipated to refill its coffers now that the debt limit has been raised, potentially creating demand for dollars.
Despite its present robustness, numerous analysts maintain the belief that it is only a question of time before the dollar reverts to its downward trajectory, which led to an 11.5% decline from its peak in September.
UBS Global Wealth Management considers the dollar as its “least preferred” currency, predicting that the Fed will likely cut rates later this year or in early 2024, reducing its yield advantage over the euro and other currencies.
While the Federal Reserve has indicated that it will likely skip an interest rate hike at its upcoming meeting in June, leaving the door open for future increases, European Central Bank (ECB) President Christine Lagarde has expressed the need for further policy tightening, which could undermine the dollar’s yield advantage.
Brian Rose, a senior economist at UBS Global Wealth Management, believes that once the Fed stops hiking rates, the market will shift its focus to the timing of the first rate cut, which is likely to weaken the dollar.