Hedge funds say greenback rally may not be over

Now is not the time to short the dollar.

The dollar’s recent strength has confounded naysayers, and according to some hedge funds, the rally isn’t over.

K2 Asset Management says the greenback will continue to charge higher as US interest rates remain elevated while AVM Capital expects rising Treasury yields to boost the currency. Alternative asset manager Clocktower Group sees further gains for the dollar if China’s stimulus continues to disappoint.

“It does look too risky to short the dollar,” said George Boubouras, head of research at K2, who sees the greenback advancing against the Australian dollar and other currencies that are sensitive to risk sentiment. “The higher-for-longer Fed funds rate theme will dominate and markets will start pricing in rate cuts in 2024 a number of times, we believe, unsuccessfully.”

A seven-week rally in the greenback is forcing dollar bears to reassess their wagers, with a string of positive US economic data undermining the case for monetary easing. Hedge funds are among those caught out by the dollar’s strength, as they have been betting against the currency since June.

The Bloomberg Dollar Spot Index is on track for an eighth consecutive week of gains, which would be the longest ever run of increases in data going back to 2005. Signs that the US economy is headed for a soft landing are bolstering bets that the Fed will keep borrowing costs higher for longer, which would burnish the greenback’s appeal.

That may spell trouble for dollar bears. BNP Paribas Asset Management forecast in July that the currency will remain weak in the coming months while Standard Bank predicted that it will enter “a multi-year downtrend” as the Fed starts to ease.

Swap traders are pricing in 75 basis points of rate cuts from the Fed between January and the end of the third quarter. Bloomberg’s dollar gauge was little changed in early Asia trading Thursday.

SHORT BETS

There are other factors that may keep driving the dollar higher: the weakening momentum in China’s economy is likely to spur demand for havens while other major currencies such as the euro are expected to remain under pressure due to subdued growth.

The euro has tumbled 5% since its July peak, while the offshore yuan slid to the weakest level since November last month. The yen, a victim of Japan’s yawning rate differential with the US, dropped more than 5% in the past quarter.

Clocktower’s chief strategist Marko Papic considers himself a “secular” dollar bear but he sees room for further tactical rallies in the US currency.

WHAT BLOOMBERG STRATEGISTS SAY…

“The cyclically bullish dollar drivers that held sway in 2022 have returned this summer, with US relative economic resilience contrasting with euro underperformance and China economic concerns. Our looming Federal Reserve rate peak narrative holds and means yield-driven dollar upside may be a thing of the past.”

Audrey Childe-Freeman, Chief G-10 FX strategist at Bloomberg Intelligence

“If Chinese policymakers continue to disappoint and if AI mania continues to see inflows into US equity markets, you could have a pop in the dollar,” said Papic. He thinks the US central bank is “being definitively behind the proverbial curve in 2024,” adding “the idea that the Fed will look to get to 2% inflation target before the election is, to me, a fairy tale.”

Over the longer term, Papic expects the greenback to weaken as a buildup in US consumer savings leads to dollars being exported overseas.

Some argue otherwise.

Great Hill Capital is buying stocks which will benefit from a falling US currency, including riskier emerging-market equities. The thinking is that the greenback’s bounce is nearing an end because the Fed will wind down its tightening cycle in the coming months.

“The continued reopening, stimulus and dollar weakening will catalyze a multiyear rally in emerging markets, China,” said Thomas Hayes, chairman of Great Hill in New York. As such, we “have a portion of our allocation focused on this theme.”

Similarly, Tribeca Investment Partners’ Jun Bei Liu thinks the greenback’s rally may have run its course for now.

“The US rates have pretty much peaked,” said Liu, portfolio manager at Tribeca in Sydney. “Certainly seems like from here on the US dollar is pretty much done as a safe haven currency as well as a leverage to the rising rates.”

YIELD SUPPORT

But for now, rising US bond yields are giving the dollar a boost, especially after benchmark 10-year rates soared to a 16-year high last month. Treasury yields may remain elevated as some Fed officials signal a reluctance to call an end to the rate-hike cycle and a deluge of issuance weighs on the market.

“We’re expecting a broad-based rally in the US dollar over the next couple of months as financial conditions continue to tighten on the back of higher bond yields,” said Ashvin Murthy, chief investment officer at hedge fund AVM Capital Pte in Singapore.