Investors' Big Dollar Short is Turning Into a Pain Trade

For most of this year, betting against the U.S. dollar has been the dominant play in the $9.6 trillion-a-day foreign-exchange market. But that trade is starting to lose momentum.

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Despite an ongoing government shutdown, the greenback has climbed to a two-month high. Traders in Asia and Europe report that hedge funds are now building up options positions that anticipate the dollar’s rally will extend through the end of the year.

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The latest rebound has been fueled by overseas weakness. The euro and yen have both slipped sharply this month, while Federal Reserve officials have cautioned against rushing into further rate cuts—comments that have strengthened the dollar’s appeal.

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For investors who have been bearish on the greenback, the continued climb is proving painful. Among those calling for further dollar weakness earlier this year were major Wall Street names such as Goldman Sachs, JPMorgan, and Morgan Stanley.

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If the dollar’s recovery keeps gathering pace, it could ripple across the global economy—complicating efforts by other central banks to ease monetary policy, raising commodity prices, and increasing debt burdens for borrowers with dollar-denominated loans. A stronger dollar could also undermine some of 2025’s favored trades, weighing on emerging-market stocks and bonds while squeezing U.S. exporters.

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Columbia Threadneedle’s Ed Al-Hussainy is one investor who has reversed his bearish stance. Once short the dollar following the 2024 U.S. election rally—dubbed the “Trump trade”—he’s now trimming exposure to emerging markets. His reasoning: markets have overestimated how aggressively the Fed will cut rates given the economy’s resilience.

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“We’ve become more constructive on the dollar,” Al-Hussainy said. “The market has priced in an overly ambitious path for rate cuts, and it’s going to be difficult to deliver that without significant labor-market weakness.”

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The Bloomberg Dollar Spot Index is up about 2% since midyear, rebounding from its steepest first-half decline in decades. The index is also up 1.2% this week—its best performance since November.

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Earlier this year, the dollar fell after President Donald Trump decided not to implement sweeping tariffs immediately after taking office, easing inflation expectations and leading traders to bet on future Fed rate cuts. The decline deepened in April when new tariffs reignited concerns about trade tensions and speculation that Trump preferred a weaker dollar to help U.S. exporters.

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However, foreign investors have not turned away from U.S. assets. Demand for Treasury securities has remained steady, while American tech stocks continue to attract global capital. Still, many investors have bought derivatives to hedge against potential dollar losses.

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Data from the Commodity Futures Trading Commission show that hedge funds, asset managers, and trading advisers remain net short the dollar, though their positions have eased since midyear. If the greenback continues to rise, those traders could face further losses.

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According to Mukund Daga, global head of currency options at Barclays, hedge funds are increasingly favoring bullish dollar options against most major currencies heading into year-end.

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Options markets also show that traders are paying a premium to protect against a stronger dollar rather than a weaker one. A gauge tracking demand for bullish versus bearish dollar bets indicates the highest optimism since April. Meanwhile, a recent Bank of America survey found that confidence in the short-dollar trade has dropped to its lowest level since early spring.

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“Investors are still wary about the Fed’s independence and what that means for the dollar,” said BofA strategists Adarsh Sinha and Michalis Rousakis. “But at the moment, their focus is elsewhere.”

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Where the dollar heads next will largely depend on the Federal Reserve’s actions. Markets are currently pricing in two quarter-point rate cuts by the end of this year and several more in 2026. But the Fed’s September meeting minutes and recent policymaker remarks suggest that future rate cuts are far from guaranteed. Inflation remains sticky, even as hiring cools.

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“Markets are now expecting a full rate-cutting cycle from the Fed,” said Mona Mahajan, head of investment strategy at Edward Jones. “That expectation explains much of the dollar’s earlier weakness, but some correction was inevitable.”

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The ongoing government shutdown has complicated forecasting by delaying key economic data. The Bureau of Labor Statistics has recalled some staff to prepare next week’s inflation report, but missing labor figures could leave markets guessing. A softer jobs report might reignite dollar bearishness, though many major banks still predict further weakness later this year.

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Some investors are also looking beyond traditional currencies altogether. Concerns over mounting fiscal deficits in major economies have revived the so-called “debasement trade,” where investors seek safety in assets like Bitcoin and gold.

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“Markets are clearly reassessing their short-dollar bets,” wrote ING analysts Chris Turner and Francesco Pesole. “But further gains may be difficult to sustain unless traders scale back expectations for Fed easing.”

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Much of the dollar’s earlier weakness came from optimism about non-U.S. growth. But that outlook has become murkier.

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In Japan, sentiment toward the yen has soured amid political uncertainty surrounding Sanae Takaichi, who recently became leader of the ruling party and is seen as favoring inflationary, stimulus-heavy policies. The yen has since weakened to its lowest level since February. Meanwhile, in France, President Emmanuel Macron’s government remains mired in crisis, pushing the euro to its weakest since August.

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Given the political backdrop in both countries, the dollar’s gains against the euro and yen could persist, said Carol Kong, strategist at Commonwealth Bank of Australia.

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“As we like to say, the dollar is still the least dirty shirt in the laundry,” added Andrew Brenner, vice chairman at Natalliance Securities. “With both the yen and euro under pressure, don’t expect major downside for the greenback anytime soon.”

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