Yellen Turning from Friend to Foe for Dollar Bulls

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Photographer: Diego Levy/Bloomberg

Janet Yellen is turning from currency traders’ best friend to their biggest foe.

The most popular trade in the $5.3 trillion-a-day foreign-exchange market has been betting on a stronger dollar, leaving investors exposed when the Federal Reserve chair damped speculation last month of an imminent increase to interest rates. As the dollar slowed its advance, an index of currency returns snapped a record winning streak, prompting traders to reassess how much higher the greenback can go.

“Currency managers had been doing well because they’ve been long dollars, and the dollar had been pretty much on a straight-line trajectory higher,” said Adam Cole, the global head of currency strategy at RBC Capital Markets in London. The dollar’s slowdown is “a major factor behind returns looking less positive,” he said.

While Bloomberg’s Dollar Spot Index climbed to a record on Tuesday, the measure is rising at the slowest pace since June and speculators including hedge funds are paring bets on how much the currency will strengthen. Yellen told Congress last week she won’t be locked into a timetable for boosting borrowing costs, just days after minutes of the Fed’s January meeting underlined the damage a stronger dollar can do to the economy.

Returns Falter

Parker Global Strategies LLC’s gauge of 14 top currency funds fell 0.1 percent in February, ending seven months of gains, the longest run in data going back to 2003. The index rose to a 3 1/2-year high in January as investors boosted long-dollar positions, or bets the U.S. currency would appreciate.

That wager worked out until the Fed undermined speculation it was planning to raise its zero-to-0.25-percent target rate in the next couple of policy meetings.

The minutes of its more recent gathering, published Feb. 18, described the strong dollar as “a persistent source of restraint” on U.S. exports, while Yellen told lawmakers on Feb. 24-25 not to assume an increase was imminent if the Fed drops a pledge to be “patient” on tightening policy.

The resulting pause in the dollar “accounts for some of that disappointment in the performance” of foreign-exchange funds, said Ian Stannard, Morgan Stanley’s head of European currency strategy in London.

Dollar Gains

Longer-term, though, he said the strong-dollar “trend should stay in place,” and predicted a gain of about 20 percent on a trade-weighted basis during the next three years.

Bloomberg’s dollar index -- which tracks the greenback against 10 major peers including the euro, yen and pound -- rose 0.4 percent last month, the smallest advance since it declined in June. The gauge had surged 16 percent from the middle of last year through the end of January. On Tuesday, it edged to its highest level since data began in 2004.

The prospect of the Fed’s first rate increase in almost a decade has lured cash to the dollar as other central banks across the globe ease. Policy makers from the euro region to China and Canada have been lowering borrowing costs or circulating unprecedented amounts of money in their economies, which tends to debase their currencies.

The dollar is forecast to strengthen versus all but four of its 31 major peers by Dec. 31, according to strategist estimates compiled by Bloomberg. At the end of last year, it was predicted to drop against 13 of them.

Biggest Bet

Still, traders have pushed out their expectations for a Fed rate increase, which is lessening the currency price swings that traders exploit for profit.

JPMorgan Chase & Co.’s index of anticipated global volatility fell to a low for the year of 8.93 percent on Feb. 25, based on closing prices. The measure peaked at a 1 1/2-year high of 11.52 percent in January and was at 9.34 percent as of 7:13 a.m. in New York.

Futures prices signal a 17 percent chance policy makers will boost rates to at least 0.5 percent by June, down from 44 percent odds six months ago, data compiled by Bloomberg show.

For the dollar to make the “next leg” higher, investors would need to “bring forward their expectations for the first rate hike,” Peter Dragicevich, a strategist at Commonwealth Bank of Australia in London, said by phone on Monday.

While bullish-dollar bets remain the biggest position in the market, investors are reducing the amount they’re speculating, according to data from the Commodity Futures Trading Commission in Washington. Net longs on the dollar versus eight major peers fell for the past three weeks to 404,276 contracts as of Feb. 27, down from a record 448,675 in January.

“They’ve been taking risk off the table because they’re seeing no clear or strong direction by the Fed that rates are going higher sooner than later,” said Paresh Upadhyaya, the Boston-based director of currency strategy at Pioneer Investment Management Inc., which oversees about $250 billion. “There’s been some frustration.”

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