It Could Have Been a Bad Time for Hedge Funds to Turn Bullish on the Dollar

The timing of hedge funds' shift from bearish to bullish on the dollar could not have been worse.

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Speculators become net long after betting against the greenback for 13 consecutive weeks according to data published by the Commodity Future Trading Commission, after betting against the greenback for 13 consecutive weeks. In the past few days, the dollar has taken a considerable tumble as the Federal Reserve moderated its language about how much more tightening may be needed, just before the Federal Reserve tempered its language.

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According to Rodrigo Catril, a senior currency strategist at National Australia Bank Ltd., who said that the lack of safe-haven bid for the dollar as a result of the US regional bank woes has caught many, including some hedge funds, by surprise. "There is a dampening effect on the dollar's outlook due to expectations of Fed easing," he explained. 

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With the ongoing turmoil in the global banking sector, it has become increasingly difficult for the Federal Reserve to gauge the movement of the dollar as its attempts to deal with elevated price pressures have become more difficult. In recent sessions, the yield on US Treasuries has been whipsawing, highlighting how rapidly the bets on the probability that the US will raise rates have changed.

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There is finally an end to one of the world's most painful trades now that the dollar has reached its peak:

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Despite the Fed signaling more tightening may follow its latest quarter-point hike, the dollar index dropped as much as 0.9% Wednesday. In Thursday's trading session, the index declined 0.4%, as traders boosted bets on next year's rate cuts.

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A strategist expects that the dollar will continue to decline against all but one of its Group-of-10 peers this week, as it has lost ground against all but one of them. As the Fed's interest rate gap shrinks, T. Rowe Price anticipates that the dollar will fall, while Carol Kong of Commonwealth Bank of Australia expects the pound to stay strong as UK inflation continues to remain high. 

A trend of gains by the South Korean won brought up Asian trading on Thursday day, rising more than 2% against the dollar. At the same time, risk-sensitive currencies such as those of New Zealand and Australia rose over 0.6% as well. 

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Several Wells Fargo & Co. strategists, including Mike Schumacher, wrote in a note that, once market turmoil and liquidity issues subside, the Fed's dovish hike is likely to lead to a broad decline of the dollar in the coming days and weeks. Especially when viewed within the context of tightening credit, it is likely that relative real rates and economic performance will not support the country as much in the coming years.

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According to some strategists, the dollar may still have a chance of recovering at some point in the future.

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At the height of pandemic fears in March 2020, investors rushed to the U.S. dollar as a haven currency in times of panic due to its reputation as a safe haven during times of stress. Markets were also jarred by jitters around Credit Suisse Group AG last Wednesday, which led to the US dollar rising 0.9% last Wednesday.  

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According to Simon Harvey, a strategist at Monex Europe, "A renewed rout in US banking stocks, especially if this has a significant impact on the flagship names, ought to keep risk conditions on a tentative footing for the time being, maintaining a fundamentally supportive aspect of the dollar on a tactical level."

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Yet, despite the positive outlook for the dollar, it is still believed that it is probably at its peak as far as strength goes. 

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According to ING Groep NV, it is expected that the euro will climb more than 5% to around $1.15 by year's end, despite the Fed raising rates on Wednesday in spite of the dovish rhetoric of the American central bank. ING Groep NV said the euro could climb more than 5% to around $1.15 by year's end. 

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There have been several reports in recent months suggesting that ING strategists, including Francesco Pesole, think the United States will cut rates in the second half of 2023. However, the cause of the decline in risk sentiment has been the absence of a floor for the dollar as panic around the banking crisis eases.