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Fed Hands Lifeline to Dollar Bulls: Currencies

U.S. Federal Reserve Chair Janet Yellen
Janet Yellen, chair of the U.S. Federal Reserve. Yellen surprised investors on March 19 by dropping the 6.5 percent unemployment-rate threshold for a rate increase. Photographer: Andrew Harrer/Bloomberg

Dollar bulls weren’t wrong about the currency of the world’s largest economy -- just early.

The bet that foreign-exchange traders supported at the start of 2014 is finally paying off after Federal Reserve Chair Janet Yellen was more hawkish this week about raising interest rates than anticipated. The Bloomberg Dollar Spot Index, which measures the greenback against the euro, yen, pound and seven other currencies, bounced back from an almost five-month low and is now 0.1 percent up on the year.

Yellen surprised investors on March 19 by dropping the 6.5 percent unemployment-rate threshold for a rate increase. That’s encouraging traders who began the year convinced the dollar would appreciate, only to see it drop as the currency was held back by a sluggish economy stemming from the harsh U.S. winter.

“The market is rebuilding dollar longs and we think it’s got quite a bit further to go,” Steven Saywell, the head of foreign-exchange strategy at BNP Paribas SA in London, said in a March 20 phone interview. “If you do see a pickup in U.S. data, a positive surprise, the market does not have that position on, so you could see the dollar rally quite strongly.”

Labor Market

Bloomberg’s dollar gauge climbed 0.9 percent on March 19 to 20, the biggest two-day increase since July, after the Federal Open Market Committee indicated it will no longer link borrowing costs to a specific jobless rate, and will consider instead a range of indicators from the labor market to inflation.

The index touched 1,023.65 yesterday, the highest level since Feb. 13, from 1,019.41 on Dec. 31. It fell as low this year as 1,011.35 on March 17 and was at 1,019.99 as of 12:02 p.m. New York time today.

The euro dropped to a two-week low of $1.3749 yesterday and the yen declined to 102.39 to the dollar, sliding from levels at about the strongest since February.

“The dollar is going to remain relatively well-supported for this year against the emerging-market currencies and in particular against the commodity-related currencies within the Group of 10,” Ian Stannard, head of European currency strategy at Morgan Stanley in London, said in a March 18 phone interview.

Morgan Stanley predicts the euro will fall more than 3 percent to $1.33 by year-end, while the median of analyst estimates in a Bloomberg survey puts the 18-nation shared currency at $1.31. The yen will end about 5 percent weaker at 108 per dollar, the U.S. bank predicts, compared with a median prediction of 110.

January’s Bulls

Traders started this year betting almost as heavily on dollar gains as they were in the summer of 2012, when Europe’s sovereign-debt crisis threatened to unravel the currency bloc, according to the Commodity Futures Trading Commission in Washington. Traders have since changed course, reducing contracts wagering on greenback gains to 118,854, from 241,987 in January.

It wasn’t just bullish-dollar wagers that investors stepped away from. Positioning across the $5.3 trillion-a-day global currency market slumped in March to the least in about three years and is only now starting to pick up, according to BNP data.

Traders moved to the sidelines of the foreign-exchange market this year as a series of their favorite bets failed to work out. Investors were buffeted by unforeseen events like Argentina’s devaluation and Russia’s annexation of Crimea, which overwhelmed the impact of themes they did anticipate, such as the diverging monetary policy between the U.S. and euro area.


“The market was caught wrong-footed,” said BNP’s Saywell whose bank, France’s largest, sees the euro falling to $1.26 and the yen sliding to 110 per dollar by year-end.

Strategists at the start of 2014 were predicting a 1 percent yen rally to 104 per dollar by the end of March. Japan’s currency has in fact strengthened 2.9 percent, headed for its best quarter since June 2012, as global turmoil boosts appetite for havens.

Likewise the euro, which has climbed 0.3 percent, compared with the 4 percent drop predicted for the first quarter by strategists surveyed by Bloomberg. The common currency has been buoyed as investors poured into the relatively high-yielding bonds of poorer European nations such as Italy and Spain.

The Fed released new forecasts this week showing that more officials predicted the benchmark U.S. rate, at a record low of about zero, would rise higher and faster than estimated, climbing to at least 1 percent by the end of next year and 2.25 percent in 2016.

Dollar Skeptic

The Fed’s interest-rate increase needs to be closer to happening for the dollar to gain “significantly” versus the euro and pound, said Kit Juckes, a global strategist in London at Societe Generale SA.

“I doubt that the move yesterday will see a significant follow-through of risk aversion,” Juckes said in a March 20 note. The G-10 currencies most likely to weaken against the greenback in the “near term” are the Canadian dollar and yen, he said. SocGen predicts the euro will fall to $1.32 and the yen will drop to 108 per dollar by Dec. 31.

The U.S. economy is forecast to improve after the snowstorms that snarled airport travel, delayed construction and damped consumer spending.

U.S. gross domestic product will expand 2.8 percent from April to June and 3 percent in the following three-month period, after growing 1.9 percent in the first quarter, according to Bloomberg economist surveys. The unemployment rate will decline to 6.4 percent by the end of the year, from 6.7 percent in February, a survey shows.

“Our outlook” earlier this year “was for broad-based dollar strength,” Mark McCormick, a macro strategist at Credit Agricole SA in New York, said in a March 20 phone interview. “We expect the U.S. economy to be the key leader in global growth, and at the same time we expect the Federal Reserve to be a bit more hawkish.”

The French lender sees the euro and yen ending 2014 at $1.30 and 115 per dollar.

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