Managers of $3 Trillion Buy Dollar Amid Worst Rout in DecadeBy
Slump ‘overdone’ as Fed hike seen, State Street Global says
Options signal growing demand to buy greenback versus yen
The dollar has been mired in its worst slump in a decade, battered by political drama in Washington and shifting bets on central-bank policy. Managers of $3 trillion say the carnage has gone on long enough.
Mellon Capital Management Corp., State Street Global Advisors and UBS Asset Management are wagering that the greenback will recoup some of its 9 percent slide in 2017 as traders embrace a scenario that was all but written off a few weeks ago: a December rate hike by the Federal Reserve. That view gained traction Wednesday after policy makers stuck to their forecast for another increase this year. The dollar surged on the announcement.
The trajectory of the dollar has far-reaching implications for financial markets. A sustained rebound may erode export earnings at U.S. companies and squelch rallies in gold and emerging-market assets, all of which benefit from a weaker greenback. After a six-month slide in the world’s reserve currency, its longest since 2007, the dollar is due for a respite in the eyes of some asset managers.
“We think this move in the dollar is overdone and are looking to fade that,” said Collin Crownover, head of currency management at State Street Global, which oversees about $2.6 trillion. Compared with Europe, the U.S. is “much more likely to either tighten monetary policy and/or have additional fiscal stimulus,” which may boost the greenback roughly 5 percent by year-end.
The currency soared in the fourth quarter on optimism for President Donald Trump’s economic pledges, and then came crashing back down along with expectations for fiscal stimulus as the administration encountered a series of political crises.
Now the narrative out of Washington appears to be shifting, leaving traders pondering whether the president’s recent dealings with Democrats may revive his agenda and the reflation trade that dominated markets after the U.S. election.
The Bloomberg Dollar Spot index Index jumped 0.5 percent on Wednesday after the Fed’s decision, and climbed another 0.1 percent Thursday, though it’s still close to its weakest since early 2015.
In addition to sticking to a median projection for a third 2017 hike, policy makers maintained forecasts for three increases next year. They also said they’d kick off the long-awaited unwind of the Fed’s $4.5 trillion balance sheet next month.
“We continue to like the dollar” against a basket of currencies, said Sinead Colton, head of investment strategy at Mellon Capital, which manages $358 billion. As for the Fed’s balance sheet, “there isn’t a playbook for how this unfolds” in markets, but tapering equates to “a de facto tightening.”
There’s plenty that could derail a December rate hike. Aside from last week’s read on consumer prices, inflation reports have mostly been tame. And a devastating hurricane season is still in full swing, although the Fed said the storms that have struck the U.S. so far would have only a near-term economic impact.
The futures market shows how deeply entrenched the market’s pessimism toward the greenback has become. Positioning by hedge funds and other large speculators toward the dollar is close to the most bearish since 2013. That’s a reversal from earlier in the year, when a survey by Bank of America Corp. found bullish dollar bets were the most crowded trade in financial markets.
Jonathan Davies, head of currency strategy in the investment solutions team at UBS Asset Management, said the market has been overly gloomy on the U.S. currency.
“The case for modest tightening is still there,” said Davies, whose firm manages about $732 billion. “That’s likely to give the dollar a little bit of a fillip” in the next six months or so, even though he sees the currency weakening longer-term.
Dollar-yen options signal the greenback may be starting to gain favor. Over the past week, nearly $13 billion more dollar calls, which give the right to buy the currency, have been bought than puts, which bestow the right to sell, Depository Trust & Clearing Corp. data show. The dollar’s one-month risk reversal against the yen, a barometer of positioning and investor sentiment, rose this week to the most bullish since June.
And on the political front, the risks may not look as crippling as before. Beyond the president’s deal-making with Democrats, Republicans lawmakers will also face pressure to deliver some form of tax cuts and infrastructure spending before elections next year, State Street’s Crownover said.
“The market’s too negative on the Trump trade,” he said. “There is a higher likelihood that we will at least get a piece of this Trump trade in, if not later this year, perhaps early 2018.”
— With assistance by Robert Fullem