Analysis-As the dollar climbs, few dare to stand in its way

NEW YORK (Reuters) – An epic rally in the dollar has investors wondering how far it can go, though many are biding their time before turning bearish on the U.S. currency.

The dollar has risen about 13% this year to a two-decade high against a basket of peers and is poised for its best year since 1997, buoyed by a hawkish Federal Reserve and investors seeking refuge against global economic uncertainty.

Its steady rise has reverberated through markets, helping to push the euro to its lowest level in more than two decades and weighing on the earnings of US companies such as Microsoft and BlackRock.

Chart: Dollar Rally –

The magnitude of the dollar’s strength took the markets by surprise.

A model used by BoFA Global Research comparing the macroeconomic fundamentals of different economies, for example, showed last month that the dollar was overvalued against the currency of all G10 countries. Moreover, history shows that while the greenback tends to strengthen before a Fed hike cycle, it begins to fall soon after, a pattern it has so far deviated from.

Still, the dollar’s momentum made investors hesitant to stand in its way.

“Almost all currencies look attractive against the dollar over the longer term, but investors need to ask themselves…what happens if you take a position and the dollar continues to strengthen?” said Brian Rose, senior economist at UBS Global Wealth Management.

Although recession fears erupted in the United States as the Fed tightened monetary policy, the outlook for many other economies looks even gloomier, increasing the appeal of the dollar. A potential energy crisis in the eurozone, for example, is making investors doubt that the European Central Bank can raise rates without hurting growth.

“You can’t have a weak USD (dollar) without a strong EUR (euro), and right now the latter is in the midst of a structural shift that will be incredibly painful,” the TD Securities analysts wrote. They think the euro could fall as low as $0.85, after breaking above $1.00 this week for the first time in 20 years.

Meanwhile, the Fed raised interest rates faster than expected in an effort to keep inflation under control, pushing yields in the United States higher than those in many developed countries. Higher rates make the dollar more attractive to investors.

Chart: G10 Policy Rate Movement –

This gap could narrow as other central banks accelerate monetary policy tightening. The Bank of Canada raised rates by 100 basis points on Wednesday, although this week’s searing US inflation reading bolstered expectations of a similar move from the Fed.

At the same time, positioning in rate futures markets shows that investors expect policymakers to raise rates quickly this year before easing them in early 2023 as growth slows.

“The moment the U.S. economy hits some sort of growth snag, the U.S. dollar is going to turn around,” said Thanos Bardas, senior portfolio manager at Neuberger Berman, who has cut dollar bets but remains bullish on the outlook. currency.

The median forecast from a Reuters poll earlier this month showed analysts expect the dollar to fall 8% against the euro over the next year. However, most also see it strengthening over the next three months.

“If you close your eyes for 12 months, the dollar will probably have depreciated by the time you open them, but there will likely be significant volatility in the meantime,” said Francesca Fornasari, head of foreign exchange solutions at Insight Investment, a British company. based asset manager, with around 817.1 billion pounds ($968.51 billion) in assets under management as of March 31.

Investor positioning shows the dollar likely has room to maneuver, Fornasari said. Net bullish dollar futures bets stood at $18.20 billion last week, down from a 2019 high of $35 billion, according to data from the Commodity Futures Trading Commission.

Dollar bears are not completely extinct.

Jack McIntyre, portfolio manager at Brandywine Global, is underweight the dollar, betting that the nearly 20% drop in US stocks this year will weigh on the economy and increase the likelihood that the Fed will end its cycle early. tightening.

“As stocks continue to weaken, this is a big tightening in financial conditions. This is going to hurt the American consumer,” he said.

Others, however, think little can stop the dollar from strengthening until there is evidence that Fed policy tightening is peaking.

“The USD remains the king of FX and it would be incredibly brave and naïve to assume otherwise,” TD analysts wrote.

(Reporting by Saqib Iqbal Ahmed; Graphics by Vincent Flassuer; Editing by Ira Iosebashvili and Jonathan Oatis)

Copyright 2022 Thomson Reuters.

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