US dollar bulls raise the threat of a pullback

Scepticism mounts as currency becomes overcrowded

NEW YORK: Some investors are concerned that the US dollar’s meteoric rise is laying the groundwork for a sharp reversal that will sting those who have sought refuge in the US currency in recent months.

Soaring US interest rates, a comparatively strong American economy and demand for a safe haven from wild gyrations in asset prices have lured investors to the US dollar, which has gained about 22% against a basket of currencies in the last year.

Some investors are concerned that the US dollar trade has become overly crowded, increasing the risk of a sharp unwind if the case for owning the currency changes and investors attempt to exit their positions all at once.

Calvin Tse, head of global macro strategy for the Americas at BNP Paribas, declared that positioning was competitive.

The US dollar can turn and turn very aggressively, he warned, if we have a catalyst.

For the week ending Sept 20, traders on the international monetary markets held a net long position in the US dollar worth Us$10bil (Rm47bil).

Despite being lower than the most recent high of about Us$20bil (Rm92bil) in July, this represents the third-longest run of traders holding bullish positions on the US dollar since 1999, with 62 consecutive weeks of long positioning.

Approximately 56% of investors in Bank of America’s worldwide fund manager survey in September named being long the US dollar as the most “crowded trade,” the third straight month the greenback has held that position in the survey.

The US dollar index fell nearly 3% over the course of two weeks beginning in mid-july as some investors staked that US inflation might be on track to moderate enough to give the US Federal Reserve (Fed) room to veer away from its course of aggressive interest rate hikes.

This may have given investors a taste of what a reversal could look like, investors said.

While a hotter-than-expected US inflation report in August dashed those hopes and sent the US dollar higher, the dangers stemming from the crowded US dollar trade have only grown.

“Undoubtedly, when you have a crowded trade, where you have investors all seeking

the same thing, when perceptions do change, the reaction is a violent one,” said Eric Leve, chief investment officer at wealth and investment management firm Bailard.

“We could easily see a 10% to 15% move the other way in the US dollar versus the euro or yen,” he said.

In 2015 and 2009, the last two instances when the US dollar index rose more than 20% during a one-year period, the index subsequently

logged a two-month drop of 6.7% and 7.7%, respectively, once the greenback peaked.

While crowded positioning can aggravate any potential reversal for the US dollar, it would take a big fundamental change to cause that reversal, investors said.

Falling US interest rate volatility, normalising European energy prices and China abandoning its zero-covid policy are three prerequisites for the US dollar to enter into a structural bear market, BNP’S Tse said.

“When those three are all checked off, it provides us more of a runway to see the US dollar enter a bear market.

“But I don’t see these happening any time soon,” he said.

While US interest rates are above those in many other economies, almost every major central bank, including the European Central Bank and the Bank of England, has hiked rates as they step up their fight against high inflation, helping boost the allure of their battered currencies.

Any signs that US inflation could be easing might help revive expectations for a dovish pivot by the Fed, robbing the greenback of a crucial driving force.

A serious blow to the US economic outlook could also hurt the US dollar, said Jack Mcintyre, a portfolio manager at Brandywine Global.

The Fed’s aggressive policy tightening has boosted worries that the US economy could be headed for a recession next year.

“The world’s three largest economies – the United States, China and the eurozone – have been slowing sharply, and even a “moderate hit to the global economy over the next year could tip it into recession,” the World Bank said in a recent study.

“I think what weakens the US dollar is an increasing likelihood that the United States goes into a recession, and that is not discounted in the US dollar,” Mcintyre said.

But with the US dollar scaling new multi-decade highs, positioning for a pullback can be painful.

“We have been fighting it a little bit, but it’s tough,” Mcintyre said. — Reuters

“I think what weakens the US dollar is an increasing likelihood that the United States goes into a recession.” Jack Mcintyre