Why the dollar looks unstoppable
THE dollar is poised to reach fresh highs in coming months as an anticipated tapering of Federal Reserve stimulus, seasonal demand and energy-driven instability unleash a wave of bullish bets on the currency.
Evidence of the greenback's dominance is rampant as inflationary pressures lift yields and stagflation worries burnish its haven credentials. It's at highs not seen since December 2018 against the yen, while CFTC data shows leveraged funds are the most bullish in over a year. Traders are paying more to hedge against gains than declines - at levels last seen around the pandemic's first wave — according to options pricing for members of the Bloomberg Dollar Spot Index.
Not even a disappointing September US jobs report derailed the currency, because 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 US interest rates would have to rise sooner than later, which would lift yields and the dollar.
Fed funds futures now imply a 90 percent chance of a rate hike by November 2022, with the odds essentially a coin flip at the end of July.
Sustained strength in the world's reserve currency risks triggering a wave of capital flows across markets. That could further sour risk appetite that's already being pressured as spiking energy prices spur angst about 1970s style stagflation. Sentiment toward the greenback was negative as the year began, leaving investors to recalculate their bets as the greenback pushes higher.
Rabobank's Jane Foley is among strategists saying the dollar is poised to gain further as 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 the market will finally begin to take Fed tapering seriously.
While the trade may look "overstretched and overcrowded" its still got some way to go yet for these reasons, according to Bloomberg Intelligence's chief G-10 FX strategist, Audrey Childe-Freeman.
“The anyway-it-wins dollar view may dominate for a while longer.”
Lagging peers
Most strategists expect the greenback to be particularly strong against low-interest currencies such as the euro and yen, because their central banks are expected to lag the Fed in raising rates.
“We are getting somewhat close to that tapering narrative in the US, 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 twothree years, so that ultimately favors long dollar positions.”
Bets on faster Fed hikes have sent the two-year Treasury yields to their highest level since March 2020, widening their gap to around 101 basis points versus their German counterparts and 44 basis points against Japanese peers.
That has left analysts chasing the currency and bond moves, with ICE's Dollar Index and 10-year Treasury yields already above consensus yearend forecasts.
Ultimate haven?
This year's high for the dollar was set in September, when investors were seeking safety as risk assets were roiled by 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. — Bloomberg.