Dollar Rebound May Inflict Pain on Crowded Trades Across Markets

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(Bloomberg) -- The surprising strength in the dollar this month is posing a major risk to consensus trades from stocks to currencies to commodities, should it continue.

A short dollar position was the second-most crowded trade, according to Bank of America Merrill Lynch’s most recent fund manager survey, while bullish hedge fund bets on the euro reached record levels based on the latest Commodity Futures Trading Commission data. Those on crude oil were also close to a record, the data showed.

“Nearly every consensual macro trade has an implicit short-dollar view built-into it,” Nomura Holdings Inc. strategist Charlie McElligott wrote in a note to clients Tuesday. “A dollar squeeze is a major risk to longs including emerging markets, crude oil, the Nasdaq, the euro, the yen and industrial metals.”

The Bloomberg Dollar Index has risen about 1.9 percent from mid-February, when it was at a more than three-year low. The MSCI Emerging Markets Index has also dropped more than 4 percent over the same period.

“We suspect that a dollar-induced rally is likely to run roughshod through the lower-yielding G-10 currencies,” such as the euro, pound, Swiss franc and yen, Mark McCormick, the North American head of foreign-exchange strategy at Toronto-Dominion Bank, wrote in a note Tuesday. “We remain medium-term dollar bears but the stars are aligning for a bear-market correction over the coming weeks.”

The euro is the most “optically obvious” loser of momentum should the dollar rally, on account of the extreme long positioning, according to Nomura’s McElligott. Emerging market equities are also very exposed, he said.

Long euro investors are set up for a “pain trade” should the dollar recover, said Ugo Lancioni, head of global currency at Neuberger Berman Group LLC. He expects that the dollar will rebound by 2 to 3 percent this quarter.

“That wouldn’t be a crazy move, but it’s a move investors probably aren’t prepared to digest right now,” said Lancioni, who helps oversee $299 billion. “My gut feeling is that many people jumped on this dollar short a bit late.”

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