Dollar Bandwagon Is Getting Crowded: Market Commentary

(Bloomberg) -- The dollar, left for dead just a few weeks ago, is suddenly the darling of the foreign-exchange market. No less than Morgan Stanley, Credit Suisse, Citigroup, Credit Agricole and Daiwa Securities have come out this week to say the greenback is a buy against any number of currencies. 

This newfound love is in stark contrast with 2017 and the first quarter of 2018, a period when the U.S. Dollar Index tumbled 12.2 percent and Wall Street firms couldn’t slash their forecasts fast enough. But now that the index has staged a bit of a rebound by rallying 3.45 percent since mid-April, strategists are taking out their pencils and coming up with newer, more bullish projections. The median mid-year forecast for the U.S. Dollar Index has jumped to 90.75 from 89.20 at the end of March. While that’s still below the current level of 92.791, it’s important to note that currency strategists are notoriously slow in adjusting their estimates in response to market swings. As for the recent gains, most strategists cite the potential for a faster pace of interest-rate increases by the Federal Reserve as the main reason for the move. The more plausible explanation may be that traders are paring back on wildly successful bets against the dollar. Commodity Futures Trading Commission data show that traders have near-record bets that the dollar will keep sliding.

One firm not buying into the rally is Nomura, which cited the growing U.S. budget deficit and debt. Japan’s biggest securities firm recommends shorting the dollar for the next three to four months against the euro and yen, according to Bloomberg News’s Ivan Levingston. “Prospects of other central banks ending their ultra-easing policies will limit the impact of Fed hikes, and we continue to be concerned about the U.S. twin deficits,” the firm’s analysts wrote in a research note. “Any dollar strength, like that seen recently, will likely be driven by risk aversion and position squaring, rather than anything more meaningful, so we stay short dollars.”

BOND RELIEF

That sound you heard was the collective sigh of relief from the bond market. Although no one expected the Federal Reserve to  raise interest rates at the conclusion of its two-day meeting Wednesday, there was some speculation that policy makers could in their usual statement express concern over faster inflation and signal to the market that it might be leaning toward four — or possibly even five— rate increases this year instead of three. Instead, they gave no indication that they are ready to veer from the path they laid out. “Inflation on a 12-month basis is expected to run near the committee’s symmetric 2 percent objective over the medium term,” the policy-setting Federal Open Market Committee said in a statement. “The committee expects that economic conditions will evolve in a manner that will warrant further gradual increases in the federal funds rate.” As the top-ranked rates strategists at BMO Capital put it in a research note before the decision, if the Fed did little at the meeting — which was what happened — that would support the case for only three more hikes this year because there wouldn’t be a lot of time in the second half to prep the market for a faster pace of increases. Treasury two-year yields dropped from 2.52 percent just before the Fed statement to as low as 2.49 percent.

EUROPE STOCKS SOAR

Europe is hot. Between mid-2017 and the end of the first quarter, the STOXX Europe 600 Index woefully underperformed, falling 2.24 percent. That compares with a gain of 8.76 percent for the MSCI All-Country World Index in the same period. But since bottoming on March 26, the European gauge has been the envy of world equity markets, rising 6.68 percent to the MSCI’s 1.09 percent decline. Much of last year’s weakness was due to the strength of the euro, which raised concern that corporate earnings would suffer as exports became more costly to foreign buyers. But now, the Bloomberg Euro Index has stalled and some of those concerns are less of an issue, especially with the European Central Bank suggesting it might not pull back from its quantitative easing measures as soon as thought with recent economic data largely coming in below forecasts. “There’s a knee-jerk reaction from the lower euro, which makes investors buy stocks. But the big question is, is the currency going down because of the rollover in the region’s macro data? If yes, this is not good news for equities and there could be a sudden change in sentiment at some point on this,” Alexandre Baradez, the chief market analyst at IG France, told Bloomberg News. Euro-area manufacturing grew at the slowest pace in more than a year in April, IHS Markit said on Wednesday.

EMERGING MARKETS ABANDONED 

Emerging markets took another hit Wednesday, with the MSCI EM Index of equities dropping and a related gauge tracking currencies falling to its lowest since the first half of January. Also, the extra yield investors demand to own the debt of emerging-market issuers instead of Treasuries has risen to the highest since July, or 2.15 percentage points as measured by JPMorgan Chase & Co. Rather than foreshadowing troubles ahead, the reversal of fortunes for emerging-market assets looks more due to investors adjusting what had become overstretched positions following the big gains of 2017. Those gains came at the expense of the falling dollar, which is now rebounding and making emerging-market assets less attractive. “We are seeing dollar strength across the board mainly because it’s under-owned on a macro basis,” Saed Abukarsh, co-founder of Ark Capital, a Dubai-based hedge fund, told Bloomberg News. Yes, there are growing political and geopolitical risks in places such as Russia, Turkey and Mexico. But emerging economies are arguably in their best shape ever. Foreign-exchange reserves for the 12 largest emerging-market economies, excluding China, topped $3.2 trillion for the first time in recent weeks, rising from less than $2 trillion in 2009 and providing an ample cushion if times get tough, according to data compiled by Bloomberg.

NOT SO PRECIOUS METALS

The Bloomberg Precious Metals Index, which tracks assets such as gold and platinum, dropped to its lowest level of the year on Wednesday. The weakness is a stark contrast with the broader commodities markets, which has maintained its positive momentum over the past month. The primary reason for the weakness has to do with the Fed, which has been signaling that it sees no slowdown in the pace of rate increases. Higher rates typically lessen the attractiveness of assets such as gold that pay no yield. Indeed, on Tuesday, when Fed policy makers started a two-day meeting to discuss the trajectory of rates, almost $186 million was pulled from SPDR Gold Shares, the world’s largest exchange-traded fund backed by the metal, according to Bloomberg News’s Luzi Ann Javier. That was the largest outflow since Feb. 9. And since precious metals typically gain in times of turmoil, evidence that the global economy is perking up has also diminished their appeal. A purchasing managers index for factories across more than 40 countries rose to 53.5 in April from March’s six-month low of 53.3, IHS Markit said Wednesday. More such data could calm investors who spent the early part of 2018 fretting about a trade war and fading global growth, according to Bloomberg News’s Simon Kennedy and Enda Curran.

TEA LEAVES

Markets will get a slew of high-level U.S. economic data to parse on Thursday. The trade balance, durable goods and factory orders reports for March, as well as the Institute for Supply Management's index covering the service economy for April are among the scheduled releases. Investors are looking for reassurance the economy is on solid ground and that tax reform is working after a government report Friday showed that the growth in gross domestic product slowed for a third straight quarter in the first three months of the year, to a 2.3 percent annualized rate.    

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