Dollar Bulls Face Historical Hurdles With Fed Close to Rate Hike

  • Greenback weakened after three previous tightening cycles
  • U.S. currency reaches strongest level since July after CPI

Dollar bulls counting on a surge in the greenback should the Federal Reserve raise interest rates this year are fighting with historical precedent.

The U.S. currency reached its strongest level since July on a report showing above-forecast inflation before next week’s central-bank meeting. The greenback pared its decline this year following the Fed’s rate increase in December. That mirrors the Intercontinental Exchange Inc. U.S. Dollar Index’s average 6 percent drop during the six months after the start of the Fed’s previous three central-bank tightening cycles.

The likelihood of a Fed rate increase by December remained above 50 percent even as currency traders parse uneven economic data. While the central bank may find the scope for additional tightening in its quest to normalize monetary policy, the pace and size of rate increases look likely to remain below historical norms, undermining relative demand for the dollar.

"You see a dollar that’s not going to react as aggressively, even if the Fed does go in December," Ben Mandel, a global strategist with JPMorgan Asset Management multi-asset solutions team, which manages $193 billion, said in an interview with Bloomberg Television. "The dollar is not going to rise significantly more from here."

The Bloomberg Dollar Spot Index, which tracks the U.S. currency against 10 of its major peers, rose 1 percent this week, touching the highest level since July 29. The measure is down 3.2 percent this year. The dollar strengthened 0.8 percent Friday to $1.1155 per euro and appreciated 0.2 percent to 102.29 yen.

Hedge funds and money managers cut net bullish positions on the dollar versus eight major peers, according to the Commodity Futures Trading Commission. Bets that the currency will rise outnumbered bearish wagers by 113,195 contracts in the week to Sept. 13, compared with 119,066 the previous week.

Fed Watch

The chances for a Sept. 21 rate increase dropped this week after a report showed August retail sales declined more than forecast before rebounding on Friday after above-projected inflation data. Traders bet there’s a 20 percent chance the central bank will raise rates next week, based on the assumption that the effective fed funds rate will trade at the middle of the new Federal Open Market Committee target range after the next increase.

The greenback rose 4.6 percent in the six-month period before the Fed hiked rates in December, according to the Bloomberg Dollar Spot Index. In the subsequent six months, it fell 3.5 percent. The start of the previous three central-bank tightenings in February 1994, June 1999, and June 2004 all tell similar tales.

The dollar is poised to weaken and will end the year at 95 yen and $1.15 per euro, said Alvise Marino, a foreign-exchange strategist at Credit Suisse AG in New York.  

The Fed is "not going to tighten at all this year," Marino said. The dollar will be at a disadvantage because of more bullish factors for the euro and the yen as central banks are "not likely to accelerate" purchases, he said.

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