Everyone’s a Dollar Bull as Taper Makes U.S. Currency a Top Bet - BLOOMBERG
OCTOBER 13, 2021
(Bloomberg) -- The dollar is starting to look unbeatable in the coming months as an anticipated tapering of stimulative asset purchases by the Federal Reserve, seasonal demand and energy-driven instability unleash a wave of bullish bets on the U.S. currency.
Evidence of the greenback’s dominance is rampant across markets at the moment. Its value against the yen is at a December 2018 high, while CFTC data shows leveraged funds are the most bullish in over a year. Plus, risk reversals, which compare the costs of options, for the Bloomberg Dollar Index show investor sentiment is near the strongest since the pandemic’s first wave.
Not even a disappointing September U.S. jobs report derailed the currency, as traders still expect the Fed to start reducing asset purchases this year. In fact, the market read inflationary signals in the report as further evidence that U.S. interest rates would have to rise sooner than later, which would lift yields and the dollar.
Rabobank’s Jane Foley is among the strategists saying the dollar is poised for further gains as U.S. yields rise and demand for emerging-market assets remains dulled. Saxobank’s John Hardy thinks the dollar could “make life miserable for the bears in Q4,” predicting that the market will finally begin to take Fed tapering seriously.
Most strategists expect the greenback to be particularly strong against so-called funding, or low-interest, currencies such as the euro and yen, because their central banks are expected to lag the Fed in raising interest rates.
“We are getting somewhat close to that tapering narrative in the U.S., and those other funding currencies are still some considerable distance away,” said CIBC’s Jeremy Stretch in an interview with Bloomberg TV Monday. “Central banks like the ECB are going to probably be on hold for the next two-three years, so that ultimately favors long dollar positions.”
U.S. two-year Treasury bonds currently yield 99 basis points more than their European counterparts and 41 more than Japanese debt. For 10-year bonds, the yield difference is 173 basis points for the euro region and 152 for Japan.
This year’s high for the dollar was set in September, when investors were seeking havens from China’s property-sector turmoil and the combination of slowing global growth and quickening inflation. It could get another lift from demand for protection as an energy crisis continues to rattle markets.
The unprecedented spike in energy prices has also been a key driver of the dollar while hurting the euro, according to Kevin Thozet, a member of the investment committee at Carmignac. He’s been increasing his exposure to the greenback for the past month or so.
“The move is likely linked to what’s happening on the commodity side,” he said. “Because the U.S. is self-sufficient on that front, and it’s not the same for the euro area.”
The euro-dollar pair has been hovering near lows not seen since July 2020, in part due to the dollar’s increasing strength. Speculators have been unwinding long euro bets since the second half of last year, with positions last week turning the most negative since March of 2020.
Zooming out, weakening global growth forecasts combined with climbing inflation makes the U.S. currency an even more attractive wager, JPMorgan’s Meera Chandan wrote in a research note Friday. “The backdrop lends itself to owning dollars on a broad basis, not only vs. higher beta currencies that are typically sensitive to growth, but also relative to other defensive currencies like JPY.”
The dollar as a haven is a relatively new phenomenon. When times are tough globally, FX traders have historically looked to the Japanese yen and Swiss franc for stability. But with unbeatable liquidity and a widening yield advantage, the U.S. currency has become an attractive venue for storing value during market turmoil, according to CIBC’s Stretch.
“Investors are looking for a certain degree of safety and security, and I think in that context from the FX perspective does lead us back toward that broader dollar narrative,” Stretch said.
Fed policy will likely give the dollar an advantage over the next few months, and not just against traditional havens, according to Mazen Issa, senior FX strategist at TD Securities. The greenback also tends to benefit from a seasonal advantage against other G-10 currencies in the fourth quarter, he said.
“Is the dollar safe haven? Against the backdrop, perhaps so. But, I think it’s more about the shift in monetary policy risks,” Issa said. “It just seems like you need to respect the dollar now.”