Stacks of U.S. one-dollar bills are arranged for a photograph in New York. (Photographer: Scott Eells/Bloomberg)

Dollar Loses Sheen for State Street as Rates Diverge From FX

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(Bloomberg) -- State Street Global Advisors has cut its dollar positions to neutral, citing rising hedging costs and a breakdown in the correlation between the global currency and rates markets.

Interest rates are the base drivers for currency movements, but that link seems to have “somewhat frustratingly broken down so far this year,” said James Binny, who oversees $116 billion as global head of currency at State Street in London. The dollar-yen rate is a “classic example,” he said.

The greenback has dropped against the yen this year even as the divergence between monetary policy in the U.S. and Japan has escalated. The Bank of Japan has repeated its commitment to an ultra-loose stance, while Federal Reserve Chairman Jerome Powell has given the impression he’s open to raising rates four times in 2017, rather than the three in dot-plot projections.

“We are more inclined to be long than short but you need to see the conditions,” Binny, whose firm oversees $2.8 trillion globally, said in an interview in Tokyo on Friday. "At the moment, we are much closer to neutral.”

The correlation between the rates and currency markets hasn’t worked this year due to a possible rebalancing of portfolios by investors as they looked to lift underweight positions in countries outside the U.S. by paring exposure to American assets, Binny said. Rising hedging costs for U.S. assets also made the dollar less attractive, he said.

Binny said he expects the dollar to rebound against the yen when markets shift their focus back to interest-rate differentials. The dollar-yen has fallen 5.6 percent this year.

The BOJ’s new deputy governor Masayoshi Amamiya said Tuesday that while the central bank could adjust its policies before inflation reaches its 2 percent target, it’s not at the point to consider that decision.

Bullish Sterling

State Street is bullish on the pound as the market seems to have priced in most of the negatives related to Brexit, Binny said. Sterling may rise through $1.40 and $1.45 “without much difficulty,” and even climb above $1.50 in the very long run, he said.

The asset manager is holding long positions in the Norwegian krone due to its low valuation and talks over possible credit tightening, Binny said. State Street is short the Swiss franc as it sees the currency as extremely overvalued given the nation’s low interest rates, he said.

Read: Krone May Be the Winner That Takes All in Scandinavia Currencies

While U.S. President Donald Trump’s tariff plans have weighed on the dollar, an escalation in trade wars could benefit the greenback, Binny said.

"The U.S probably does lose less than others because it’s a very self-contained economy," he said. “They are much less dependent on global trade, particularly now, as they produce a large amount of their own oil. So it is probably better for the U.S. dollar in the medium term.”

“Currencies of countries that are very dependent on global trade, such as Sweden and Australia, will suffer,” he said.

©2018 Bloomberg L.P.

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