Speculators are cutting the dollar too short
Hedge funds are making their biggest bet in seven years that the dollar will weaken, as evidence mounts that US economic momentum is slowing, thus limiting the scope for higher interest rates.
The flattest yield curve in over a decade, with the gap between 10-year and two-year US yields shrinking to just 46 basis points, suggests the current trajectory of Federal Reserve tightening is already putting the brakes on the economy.
Trouble is, there are signs that growth is slowing in other major economies too, meaning other currencies will also come under downward pressure. The greenback may not fall as far or as fast as speculators are banking on.
Even if the Fed delivers only three more rate hikes this year rather than the four that had been widely expected, that could still be three more than we get from the European Central Bank, Bank of Japan or Bank of England. Short-term bond yield differentials, often seen as a key driver of exchange rates, certainly don’t fit with a short dollar strategy. The two-year US-German yield spread is nearly 300 basis points, the widest in favour of the dollar since 1989.
All of which explains why the dollar hasn’t really gone anywhere at all for the last few months and why speculators are struggling to make money on their huge short dollar positions.
Chicago futures markets data show that hedge funds and other speculators now hold the biggest short dollar position since August 2011. According to calculations by Reuters and Commodity Futures Trading Commission data, the value of that bet, derived from net positions of International Monetary Market speculators across a range of major and emerging currencies, now stands at $27.2 billion.
Almost all of that is made up of a net long euro position of 147,463 contracts, the second most on record, worth $22.8bn.
Hedge funds trading currencies and rates had a difficult first quarter, in large part thanks to the “volmageddon” burst of extreme market volatility in early February that crushed momentum and trend-following strategies.
Eurekahedge’s CTA/Managed Futures hedge fund index fell 0.33 per cent in March, and was down 1.54 per cent over the quarter, while its Macro hedge fund index fell 0.71 per cent in March and was down 0.4 per cent in the quarter. Currency trading is a big part of these two indices.
Eurekahedge’s FX index fell 0.98 per cent in March, and is down 0.2 per cent year-to-date.
The dollar index, a measure of the greenback’s value against a basket of major currencies, has barely moved since mid-January, confined to a narrow range of 88.5 to 91.0.
But you can see why hedge funds and speculators are shorting the dollar. The Atlanta Fed’s GDPNow forecast model predicts 2 per cent annualised GDP growth in the first quarter.
It was 3.5 per cent at the start of March. The latest US employment and consumer confidence figures were among a growing raft of economic indicators to undershoot expectations. Citi’s economic surprises index has tumbled this month, and is now the lowest since October.
But it’s still in positive territory, unlike the comparable eurozone, UK and Japanese indices. Citi’s eurozone economic surprises index, in particular, has fallen off a cliff in recent weeks and is now its lowest since June 2012.
All this suggests there’s not much upside to the dollar’s main competitors either. And in the relative world of exchange rates, not all currencies can depreciate at the same time.
Shorting the dollar is proving to be a risky gamble. The larger that bet grows without an accompanying fall in the dollar, the greater the chance that speculators throw in the towel and cut their short positions.
There are signs that growth is slowing in other major economies too, meaning other currencies will also come under pressure