Dollar Strikes Back as Jobs Data Revive Fading Divergence Trade

  • Greenback posts biggest weekly gain in a month versus euro
  • Steepest advance comes against pound, after BOE cut rates

Fed Rate Hike Probability Jumps on Jobs Data

The latest display of strength in the U.S. labor market is breathing new life into the dollar divergence trade.

A broad measure of the greenback extended a rebound from its weakest level since June after Friday’s report on July job growth trounced forecasts and bolstered bets that the Federal Reserve will raise interest rates this year. Traders now see about a 47 percent chance of a hike by December, up from about 35 percent at the end of last week.

The Fed speculation revives a scenario favored by dollar bulls, where the U.S. central bank moves toward tightening policy as other central banks add stimulus to bolster flagging economies. Case in point: the Bank of England cut interest rates this week for the first time in seven years, turning the pound into the biggest loser versus the greenback among major currencies.

“We’ve been long-term bullish on the dollar and we continue to be,” said Kathy Jones, New York-based chief fixed-income strategist at Charles Schwab & Co. “This number should push us more towards a rate hike and more divergence.”

The Bloomberg Dollar Spot Index, which tracks the currency against a group of major peers, rose 0.4 percent this week. The greenback gained 0.8 percent to $1.1086 per euro and sank 0.2 percent to 101.82 yen.

Consensus Upended

The U.S. currency index is still down almost 4 percent in 2016, upending expectations at the start of the year that the dollar would strengthen for a fourth straight year. Those forecasts faltered as financial-market turmoil and the U.K. referendum on membership in the European Union led the Fed to forgo hiking rates again, following liftoff from near zero in December.

The labor report is welcome news for hedge funds and other large speculators in the futures market, who boosted bullish wagers on the dollar the past four weeks, data from the Commodity Futures Trading Commission show. Bets the greenback will rise outnumbered bearish wagers by about 149,000 contracts in the week to Aug. 2, the most since February.

The U.S. currency is projected to strengthen to $1.08 per euro and 105 yen by the end of the year, according to the median forecasts in Bloomberg surveys of analysts.

"We’ve seen ongoing divergence for some time now,” said Eric Viloria, a currency strategist at Wells Fargo Securities LLC in New York. “It never really went away. We see today’s solid payrolls data as supportive of a resumption in Fed interest-rate hikes, and we expect the U.S. dollar to remain supported in the near term."

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