Dollar Confounds Strategists Ripping Up Forecasts on Market Rout

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  • Greenback sinks 6% versus yen, 4% against euro this year
  • Biggest banks called for U.S. currency to strengthen in 2016

Currency forecasters are getting steamrolled by the $5.3 trillion-a-day market as traders all but abandon bets that monetary policy divergence between the world’s major central banks will fuel a third year of dollar gains.

Strategists have been left in the lurch as the most popular trading recommendation of 2016 implodes. The chances of the greenback strengthening beyond median year-end forecasts of $1.06 per euro and 123 yen have fallen to less than 23 percent, from 41 percent on Dec. 1, options prices imply. 

Global financial-market turmoil, and the reaction of central banks, are forcing forecasters to tear up predictions for dollar strength 40 days into the new year. Foreign-exchange traders have dropped the idea that American economic out-performance will allow the Federal Reserve to raise interest rates and add to the allure of dollar-denominated assets, while central bankers in Tokyo and Frankfurt add to stimulus to fend off slowing growth and sliding inflation.

Strategist “forecasts will be adjusted, reflecting less dollar upside potential, especially versus the euro and yen,” said Alessio de Longis, a New York-based money manager in OppenheimerFunds Inc.’s global multi-asset group, which manages $5 billion. “All the forecasts were very, very aggressively tilted toward more dollar strength, and it’s not clear at all that we’re getting that.”

Outcome Odds

Fed Chair Janet Yellen said this week that continued turbulence may throw the central bank off course from the multiple rate increases that policy makers have signaled for 2016.

Options markets show that the dollar has only a 22 percent probability of rising beyond the median analyst forecast of $1.06 per euro by the end of the year. That’s the lowest in three months. The chances of the U.S. currency surging past strategists’ year-end estimate of 123 yen have plunged by more than half, to 14 percent, in the same period.

The greenback has dropped more than 6 percent this year to 112.96 yen as of 12:04 p.m. New York time on Friday, and is down almost 4 percent at $1.1233 per euro.

Some analysts have been quicker than others to adapt their views. 

Credit Suisse Group AG turned bearish on the dollar for the first time since the currency started rallying in mid-2014. The bank revised its greenback forecasts this week and projects it sliding to $1.17 per euro in the next three months, reversing a previous call for a gain to $1.08. It also expects the dollar to weaken to 110 yen in the same period, instead of strengthening to 120.

On Target

For HSBC Holdings Plc, it’s been no surprise that the dollar’s rally has run out of steam. The bank has been skeptical of the currency’s upswing since March 2015 and its contrarian picks for this year’s top trades are to sell the dollar against the euro and yen.

“You’re getting direction from the Fed that their thinking of the U.S. economy has been more cautious and they highlighted the downside risk -- that’s where the weakness in the dollar gets more traction,” said Daragh Maher, the bank’s head of U.S. currency strategy in New York.

At the same time, “the ability for other central banks to push back against currency strengths will be constrained,” he said. The greenback has already fallen below the bank’s year-end forecast of 115 yen, and HSBC expects the dollar to weaken further against the euro by the end of 2016.

The options market is also contradicting other euro forecasts. The shared currency has a 21 percent probability of falling below its year-end target of 72 euro cents per pound and a 30 percent chance of slipping below 9.05 Swedish krona per euro.

Price Swings

The derailed forecasts coincide with wider price swings this year. A JPMorgan Chase & Co. gauge of volatility has surged to the highest since December 2011. 

In presenting the Fed’s semi-annual economic report to Congress, Yellen said the turbulence had “significantly” tightened financial conditions by pushing down stock prices, driving up the dollar and raising some borrowing costs.

“Persistent risk aversion, a large shift in U.S. rates expectations and diminishing returns to European Central Bank and Bank of Japan policy easing all force our hand,” analysts including Shahab Jalinoos, global head of foreign-exchange strategy at Credit Suisse in New York, said in a note. “These new forecasts will come as a disappointment to longtime U.S. dollar bulls, including ourselves.”