Markets Adjust Positions as 'Sell the Dollar' Trade Loses Appeal

The U.S. dollar’s rebound in July is prompting a shift in strategy among emerging-market investors, with many now anticipating that the currency could continue gaining strength in the months ahead. Asset managers, including T. Rowe Price Group Inc., Barclays Plc, and Fidelity International, are adjusting their approaches as the dollar’s resurgence challenges previous bets on its decline.

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T. Rowe Price has shifted its preference toward dollar-denominated emerging-market bonds over those issued in local currencies. According to Leonard Kwan, a fund manager based in Hong Kong, these bonds currently offer more attractive yields. Kwan expects the dollar to enter a “consolidative period” over the next three to six months, which could limit the potential returns from local-currency debt during this time. This tactical shift reflects broader investor sentiment that emerging-market assets may face headwinds if the dollar continues to strengthen.

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Recent performance data supports this trend. In July, emerging-market dollar bonds significantly outperformed their local-currency counterparts. A Bloomberg index tracking dollar-denominated bonds delivered a 0.9% return, while an index for local-currency bonds declined by the same margin. Currency markets mirrored this pattern: Bloomberg’s dollar spot index rose 2.7%, ending a six-month losing streak, while MSCI’s emerging-markets currency index fell 1.2%.

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Despite a sharp pullback on Friday—when weaker U.S. job data spurred speculation that the Federal Reserve might cut interest rates as early as next month—the dollar still posted a 1% gain for the week, marking its best weekly performance since November.

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Barclays Plc has also advised caution for investors expecting the dollar to weaken against Asian currencies. In a recent note, strategists led by Lemon Zhang recommended taking long positions on the U.S. dollar against certain low-yielding Asian currencies that appear overvalued or face country-specific risks, such as the Thai baht and Hong Kong dollar. Barclays further highlighted opportunities in relative-value trades that do not involve the greenback directly, such as shorting the Thai baht against the South Korean won or anticipating a weaker Singapore dollar relative to the Chinese yuan.

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Meanwhile, Fidelity International is warning investors who rely on the dollar as a funding currency for carry trades to reconsider their approach. Carry trades involve borrowing in a currency with low interest rates and investing in assets denominated in a higher-yielding currency.

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According to Lei Zhu, Fidelity’s head of Asian fixed income, persistently high U.S. interest rates reduce the appeal of borrowing dollars for this strategy. Zhu suggests exploring alternative funding currencies like the Hong Kong dollar, which currently has lower short-term funding costs than the U.S. dollar, or even the Chinese yuan, which could serve as a cheaper source of leverage.

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The dollar’s July rebound is also having implications for hedging strategies across Asia. For funds holding dollar-denominated assets, it has become less expensive to hedge currency risk. Bloomberg data shows that the aggregate cost of hedging for local-currency funds—measured by dollar-Asia forward implied yields across eight regional economies compared to the U.S. secured overnight financing rate—fell by five percentage points last month. This marked the first significant drop in hedging costs this year.

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Zhu notes that with the dollar strengthening, investors who are currently unhedged or underhedged may take this opportunity to scale back their U.S. dollar exposure. “Entities may view this as a chance to rebalance their positions and reduce foreign-exchange risks,” she said.

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Overall, the greenback’s resurgence is reshaping market dynamics. After months of dollar weakness fueled optimism in emerging markets—driving MSCI’s emerging-market equity index to its highest level in more than three years and its currency index to six straight monthly gains—the trend is now reversing. With analysts and fund managers increasingly betting on continued dollar strength, emerging-market investors face renewed pressure to adjust bond allocations, rethink carry trade strategies, and fine-tune hedging practices to navigate the shifting currency landscape.

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