Currency Managers Grasp for Next Winning Trend as Dollar Falters

Updated on
  • Krona climbing after faster inflation reduces easing bets
  • Weaker-dollar trend almost at end with Fed seen acting again

After years of global easing made buying the dollar one of the world’s most popular trades, currency traders are latching on to any glimmer of economic brightness to try to uncover the next big theme.

Even hints that central bank stimulus may be no longer required is enough to spark buying. Sweden’s krona climbed last week to its strongest level against the euro since January after a report showed the nation’s inflation rate exceeded economists’ predictions in March, damping bets for further easing. In Canada, a recovery in crude oil and non-commodity exports pushed the currency to the biggest gains in the developed world during the past three months, even as the central bank warned of the currency’s strength.

Options trading signaled that after the traditional havens of the yen and Swiss franc, the Canadian dollar and the krona will perform the best versus the dollar in the next year among major currencies. Among major currencies, traders are only pricing in interest-rate increases in Sweden and the U.S. in the next 12 months.

QuickTake The Almighty Dollar

“We’re about to shift into a regime in which the market will start speculating which central bank will give up easing,” said Athanasios Vamvakidis, a London-based head of Group-of-10 currency strategy at Bank of America Corp.’s Merrill Lynch division, who sees the dollar strengthening to one-to-one versus the euro by the fourth quarter. “So if there’s a next big foreign-exchange trade, it’s likely to be driven by this shift to a new regime.”

Since volatility among major currencies fell to a record low in 2014, investors have been seizing on any signs of central-bank tightening. The dollar surged about 20 percent in the two years through 2015 as investors awaited the Federal Reserve’s first rate increase since the financial crisis, a move that helped boost the very market turmoil that helped stay the central bank’s hand. In the U.K., speculation that the Bank of England would be the first to move pushed the pound to an almost six-year high in July 2014, only for it to tumble almost 20 percent as rate-hike bets were pushed further into the future.

Throughout that time, and in the easing that preceded it, traders were unable to take full advantage of the strong movements in currencies, such as the yen’s more than 40 percent decline between 2011 and 2015. A Parker Global Strategies LLC index that tracks top funds in the industry has fallen for four of the past five years, and is less than 0.5 percent stronger in 2016.

Currency Danger

The danger for central banks is that renewed currency strength ends up undermining the economic improvements, or, as happened with the Fed, delays further rate increases.

In the crosshairs is Sweden, whose currency has gained at least 0.9 percent against both the euro and the dollar in the past month. A growing number of strategists are suggesting that officials will have to accept a stronger currency, signaling that record amounts of stimulus and the Riksbank’s threat of currency intervention are losing potency.

Nordea Bank AB, the largest lender in the Nordic region, sees the krona climbing about 3 percent versus the euro this year and Danske Bank A/S, Denmark’s largest, last week raised its forecasts for the currency because it no longer believes that the Riksbank will expand its asset-purchase program on Thursday. The central banks of Norway and Sweden will be among the first to stop easing, fueling gains for their currencies, Vamvakidis said.

Appreciation Risk

“Clearly, the first central banks not to sound dovish risk seeing their currency appreciate sharply,” said Niels Christensen, chief currency strategist at Nordea, who predicts the Swedish currency will strengthen to 8.90 per euro by Dec. 31, from 9.18 on Wednesday. “Globally, no central bank or country would like a strong currency and that’s also been the message from the Riksbank, but looking at the numbers if there is one economy that can handle a stronger currency it would be the Swedish one.”

Bank of America and Commerzbank AG, Germany’s second-largest bank, haven’t given up on the dollar rally, even after its biggest quarterly decline versus the euro in five years.

The dollar is already showing signs of recovering, gaining almost 1 percent since falling to a six-month low of $1.1465 per euro on April 12. It was at $1.1364 versus the common currency as of 9:49 a.m. in London on Wednesday. The median of analysts’ predictions compiled by Bloomberg is for the dollar to gain to $1.10 by the end of December.

The euro jumped 1.6 percent March 10 after European Central Bank President Mario Draghi suggested he didn’t see any need to reduce rates further. That was enough to spark a turnaround in the currency even though the institution had that day reduced all its key interest rates and unveiled a package of stimulus measures that exceeded analysts’ predictions.

Futures, which show a 55 percent probability of another quarter-point Fed hike by December, may get caught out as policy makers project as many as two boosts this year, after increasing rates on December for the first time in almost a decade. The central bank “will be raising rates faster than what’s reflected in the financial markets,” Fed Bank of Boston President Eric Rosengren said this week.

“Those who, from their perspective, have already solved their low-inflation problem are the ones that can get more active,” said Ulrich Leuchtmann, Frankfurt-based head of currency strategy at Commerzbank. “It should be the Norges Bank but it isn’t for some other reason. Another one is Canada because there also you don’t have a problem of inflation that’s too low.”

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