(Bloomberg) – The dollar has outperformed all major currencies over the past nine months on the prospect of interest rate hikes from the Federal Reserve, but the end of its rally could be in sight, if history is a guide.
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The U.S. currency has weakened an average of 4.1% over the previous four Federal Open Market Committee tightening cycles, based on U.S. central bank and Bank for International Settlements data dating back to 1994.
“History shows that the dollar goes down more often than it goes up when the FOMC tightens, especially early on,” strategists including Joseph Capurso and Carol Kong of the Commonwealth Bank of Australia in Sydney wrote this week. , in a note to customers.
Commodities and Asian currencies typically strengthen against the dollar when the Fed raises rates, with investors viewing the hikes as a sign of improving global growth and demand for resources, they wrote.
The Bloomberg Dollar Spot Index has jumped more than 7% in the past nine months, around the time its current uptrend began. Over the same period, the US currency has strengthened against all of its 16 major counterparts.
The rally was driven by improving US economic growth and accelerating inflation which led traders to bet on another round of Fed rate hikes. The central bank will deliver the first of those at its two-day meeting ending Wednesday, according to 88 economists polled by Bloomberg. A total of seven hikes are now scheduled for this year, according to data from Bloomberg.
Read more: The Fed prepares a 25 bps hike, with a more uncertain path thereafter
Not everyone is convinced that the dollar rally is coming to an end.
If the Fed turns even more hawkish than expected this week, investors could see that as yet another reason to jump on the dollar bandwagon.
“If the United States were to lead the world in taking action against sustained levels of inflation, we could see forex traders jump on the theme of ‘interest rate differentials,'” said Brian Gould, head of the trading at Capital.com in Melbourne. “The allure of owning higher-yielding currencies, whose countries have higher central bank interest rates, may dominate medium-term themes and push the US dollar higher.”
Still, signs are emerging that the greenback’s rally is starting to look too stretched.
Hedge funds have reduced their net long dollar positions against a basket of eight other major currencies in each of the past four weeks, according to Commodity Futures Trading Commission data compiled by Bloomberg. At the same time, much of the positive news for the dollar is already priced in.
The outlook for the dollar is far from entirely positive, it’s just “the least dirty shirt in the laundry basket,” said Rodrigo Catril, strategist at National Australia Bank Ltd. in Sydney. Even if the Fed bumps its 2022 midpoint chart from three hikes this year to four or even five, that’s unlikely to translate into a lasting boost for the greenback, he said.
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