Traders Bet Dollar Will Keep Climbing

Traders Bet Dollar Will Keep Climbing

Traders Bet Dollar Will Keep Climbing

The U.S. currency hit its highest level in three weeks on Monday, reflecting expectations that the Federal Reserve could increase short-term interest rates as soon as next month

Investors are dusting off the rising-dollar playbook.

The U.S. currency hit its highest level in three weeks on Monday, reflecting expectations that the Federal Reserve could increase short-term interest rates as soon as next month. Higher rates make dollar-denominated assets more attractive.

Traders are on the lookout for signs the dollar could surge further against the yen, euro and some emerging-market currencies. Currency gains this year have hampered sluggish economic recoveries in many nations. The Wall Street Journal Dollar Index is down 4% in the year to date, confounding many analysts who predicted the dollar would rise in 2016.

Bets on a stronger dollar stood at $7.18 billion in the week ended Aug. 23, down from nearly $15 billion in late July, according to data from the U.S. Commodity Futures Trading Commission and Scotiabank.

Investors are “underexposed to the U.S. dollar right now,” said Shaun Osborne, chief FX strategist at Scotiabank.

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Any large currency shifts could roil other asset classes, from U.S. stocks to emerging-markets bonds to many commodities, that have benefited from the dollar’s weakness.

One potential catalyst: A strong U.S. payroll number this Friday could bolster the case that Fed officials have recently made for higher rates. Last Friday, Chairwoman Janet Yellen and Vice Chairman Stanley Fischer said the economy was strong enough to warrant the first increase in the federal-funds rate this year. The comments spurred the biggest one-day rally in two months in the WSJ Dollar index, which tracks the value of a basket of 16 currencies.

“We have a period of dollar strength ahead,” said Daniel Katzive, head of FX strategy for North America at BNP Paribas.
A stronger dollar boosts the purchasing power of U.S. consumers and businesses and pushes down inflation by making imports cheaper. But it also hits the profits of U.S. multinational companies with large overseas operations, a sizable and closely watched segment at a time of soft domestic economic growth. And with inflation running below the Fed’s long-term target in recent years, even price stability has its down side.

The dollar’s strengthening is more problematic abroad, an effect that became evident during the global selloff in many asset classes in the first two months of 2016.

Commodities including oil are priced in dollars, and become more expensive to foreign buyers when the dollar strengthens. This pressure limits demand for those goods in those nations and can lead to a cycle of falling prices and soft global demand that can send bearish market signals about the health of the world economy.

A stronger dollar could be good news in Europe and Japan, which for years have struggled with slow growth and low interest rates. Currency appreciation in those regions has stifled efforts to gain competitiveness through easier monetary policy.

But a strengthening in the greenback likely also would hit emerging markets such as Brazil and Turkey, which have received billions of dollars of investor inflows this year. Many corporate borrowers there owe money in dollars. Those loans offered lower rates at inception but stand to become costlier to repay if the dollar rises, raising concerns about the potential for a broad and disorderly selloff.

At the same time, many investors are hesitant to bet on the Fed, which has stood pat after delivering a single rate increase late last year—a much slower pace of tightening than many investors had expected.

The central bank has been wary of damaging an uneven U.S. recovery by raising rates too quickly, while also fearing that higher borrowing costs in the U.S. could destabilize global markets. Potentially amplifying those concerns are negative rates adopted in Japan and Europe, which could intensify any shift into the dollar.

Most traders expect the Fed to raise rates just once in the next year, CME Group data show.

BNP Paribas predicts the dollar will rise about 1.7% against the euro to roughly €0.90 by the end of the year and 6% vs. the yen to ¥108.

But even investors who expect the Fed to raise rates this year appear skeptical that more rate increases will quickly follow. Fed-funds futures show that investors see only a 30% chance that the Fed will raise rates twice by next July, according to CME data.

Fed officials also are starting to acknowledge this “lower for longer” reality. San Francisco Fed President John Williams earlier this month suggested that the central bank consider a higher inflation target as a way to adapt to lower interest rates.

Tom Nakamura, a portfolio manager at Toronto-based AGF Investments, expects uncertainty over the Fed’s future plans for raising rates will temper the dollar’s rally. He is maintaining bullish bets on emerging-market currencies and the Canadian dollar.

“It’s becoming difficult for the market to think of what kind of path the Fed is on,” said Mr. Nakamura, whose firm manages about 34 billion Canadian dollars ($26 billion). “We do think the dollar will do OK, but it’s not going to be a big trend upward.”

Traders Bet Dollar Will Keep Climbing

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