Dollar Bulls Gain Ground on Fed First-Mover Status

Currency traders are betting the Federal Reserve has stolen a march against rival central banks on the road to higher interest rates.

While Fed Chair Janet Yellen told lawmakers last week the U.S. still needs accommodative monetary policy, she also said borrowing costs may rise sooner than expected. European Central Bank President Mario Draghi last month cut a key rate below zero, and the Bank of Japan is buying about 7 trillion yen ($69 billion) of government debt a month to try to banish 15 years of deflation.

The dollar is benefiting. The U.S. currency strengthened versus all of its Group of 10 peers this month, and the Bloomberg Dollar Spot Index is on course for its biggest advance since January.

“The message from Yellen is not obviously dovish, even though plenty in the market are characterizing it as such,” Greg Gibbs, the Singapore-based head of Asia-Pacific markets strategy at Royal Bank of Scotland Group Plc, said by phone on July 22. “We’re getting to the turning point for the dollar as we begin to see an upward creep in front-end yields.”

With the U.S.’s first rate increase since 2006 forecast for next year and the Fed on course to end its currency depreciating bond-purchase program by December, investors are becoming more optimistic about the dollar. That’s a turnaround from the first half, when the greenback suffered its first back-to-back quarterly declines versus major trading peers since 2011.

Dollar Index

Bloomberg’s dollar gauge, which tracks the currency against 10 major counterparts, has gained 0.9 percent this month, paring its 1.6 percent decline from January through June. The index was at 1,012.24 as of 12:13 p.m. in New York, the highest level since June 18, after touching a six-month low of 1,000.59 on May 8.

The dollar has strengthened 1.7 percent against the euro this month and touched $1.3438 today, the strongest level since November. The rally has come as demand for U.S. assets climbs, with the Standard & Poor’s 500 Index of stocks at record highs and Treasury yields near the lowest level since June 2013.

Fed officials are nearing their goals for full employment and price stability faster than they’d forecast.

The U.S. central bank has kept its benchmark rate in a record-low range of zero to 0.25 percent since December 2008. A Credit Suisse Group AG swaps gauge shows traders pricing in a 0.17 percentage-point increase over the next year, matching the highest odds on policy tightening since March.

Faster Recovery

“Even the Fed doves are beginning to talk about the U.S. economy recovering faster than expected” and to link it with “tightening monetary policy,” Steven Englander, the head of G-10 currency strategy at Citigroup Inc. in New York, said in a July 18 Bloomberg Radio interview. “When the Fed begins to tighten,” then “it becomes a much more dollar-positive story.”

St. Louis Fed President James Bullard, San Francisco’s John Williams and Philadelphia’s Charles Plosser signaled this month the possibility of a faster-than-anticipated rate increase. Chicago’s Charles Evans and Atlanta’s Dennis Lockhart countered that slow inflation and labor-market slack will allow higher rates to be delayed until the second half of 2015 or 2016.

‘More Rapid’

“If the labor market continues to improve more quickly than anticipated” by policy makers, “then increases in the Federal funds rate target likely would occur sooner and be more rapid than currently envisioned,” Yellen said in testimony to the Senate Banking Committee on July 15.

She also told lawmakers that the central bank must press on with stimulus because “significant slack” remains in labor markets.

The U.S. jobless rate fell to 6.1 percent last month, the lowest in almost six years and near a level Fed officials didn’t expect to see until the end of 2014.

Consumer prices climbed 2.1 percent in the year through June, official data showed this week. The Fed’s preferred inflation gauge rose 1.8 percent in May from a year earlier, the most since October 2012 and compared with the central bank’s 2 percent target.

The dollar’s gains may be capped as rising consumer prices and low rates limit inflation-adjusted yields on U.S. bonds, according to JPMorgan Chase & Co. The so-called real yield on the 10-year Treasury was at 0.44 percentage point, close to a 15-month low.

Real Yields

“It’s much more difficult for the U.S. dollar to have a meaningful rally while U.S. front-end rates in a real sense are going down,” Sally Auld, a senior strategist for currencies and rates at JPMorgan in Sydney, said July 22.

With this month’s rally, dollar bulls finally see the chance of vindication after a first half when they missed out on the gains they’d anticipated. At the end of last year, the median forecast in a Bloomberg strategist survey was for the dollar to rise 4.9 percent to $1.31 per euro by June 30. It ended up strengthening just 0.4 percent to $1.3692.

The ECB became the first major central bank to take the deposit rate negative last month while lowering the benchmark refinancing rate to a record 0.15 percent, with Draghi saying on July 14 that currency appreciation is “a risk to the sustainability of the recovery.”

The euro will fall 2 percent to $1.32 by year-end, according to the median forecast of more than 50 economists and strategists in a Bloomberg survey. The yen will weaken about 3 percent to 105 per dollar, according to a separate survey.

The chance of a rate increase at the Fed’s June 2015 meeting rose to 45 percent yesterday, from 40 percent at the end of last month, while the odds of a July move increased to 59 percent from 53 percent, according to futures prices.

“We’re in the early stages of a dollar bull cycle unfolding now,” Paul Mackel, the Hong Kong-based head of Asian currency research at HSBC Holdings Plc, said by phone on July 22. Officials “increasingly seem confident that, come late next year, they’ll be in a better position to start normalizing monetary policy.”

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