Investors are prepared for the dollar to rise next year. But the juiciest trades may have ended even before the end of 2021.
Everyone from Morgan Stanley to Sumitomo Mitsui Trust Asset Management to Lombard Odier is predicting a stronger dollar in 2022, with the caveat that its advance will be moderate. This is because traders have been at the forefront of an aggressive Federal Reserve, choosing to buy the world reserve currency against virtually all of its peers before borrowing costs rise.
“The dollar is expected to strengthen in the first half of 2022, as the Fed will probably finish cutting in March and start raising rates in June,” said Naoya Oshikubo, Sumitomo’s chief manager, who oversees about $ 740 billion in assets. The dollar may give up some of its gains in the second half, although “its adjustments will be moderate, only to eliminate the excess of rally related to the expectations of increase before the rate hikes.”
With an increase of about 5% this year, the Bloomberg Dollar Spot Index is poised for its best annual gain in six, while the positioning of the funds has turned more optimistic since 2015, according to a survey by Bank of America Corp. Hedge funds’ net long bets on forex have risen to their highest level since June 2019 as expectations about the impact of tighter US monetary policy mount.
It’s a 180-degree turn from this time last year when the dollar short sale was one of the busiest trades on Wall Street.
That hypothesis of a larger US deficit and a broad global recovery that favors non-US assets and weakens the dollar did not work. Instead, monetary stimulus from the Fed helped fuel a rally on Wall Street that sucked in more money from around the world as most emerging markets languished.
Now, with traders bracing for rate hikes, some suggest that dollar gains may falter in 2022, or that the currency may even fall.
“Historically, the dollar has traded strongly in the six months before the first interest rate hike in the United States,” said Arjun Vij, portfolio manager at JPMorgan Asset Management, who sees the dollar gaining against the euro, the Swiss franc and the yen. But with rate hikes from two to three already in the markets, “there is a possibility that the bond market will try to price a policy error in the United States.”
Eurodollar futures prices suggest traders expect at least three rate hikes from the Fed next year.
Inflation risk is on Morgan Stanley’s radar, even as the company recommends long positions in dollars against lower-yielding currencies, including the euro.
If inflation slows next year, some members of the Fed committee might argue for patience in raising rates, said David Adams, head of foreign exchange strategy at the G-10 in New York.
“That policy divergence narrative that turns into a policy convergence narrative, where maybe the Fed is a little more dovish than people expected, but other major central banks are starting to move out, most likely is that it is negative for the dollar “. he said.
Morgan Stanley Sees Two Fed Rate Hikes In 2022 In An Updated Outlook
Meanwhile, Mirae Asset Global Investments money manager Malcolm Dorson sees an opportunity for dollar momentum to reverse in 2022 as US fiscal stimulus rolls in and vaccination rates decline while the rest of the world recovers.
“As global vaccination rates improve and the world begins to live with Covid-19 as endemic, the ‘flight to quality’ trade should relax, providing more tailwinds for international currencies,” said Dorson.
The prospect of a short omicron wave followed by a global recovery that brings a measure of dollar weakness is a possibility for Eric Stein, director of fixed income investments at Eaton Vance.
All of this points to tactical trading with the dollar in 2022 and strategists expect the ICE US dollar index to rise just over 1% for the fourth quarter, according to data compiled by Bloomberg.
“This is a modest dollar strength and more nuanced views,” said Homin Lee, a macro strategist at Lombard Odier in Hong Kong. The firm, which is currently long dollar positions in some portfolios, expects the euro to weaken to 1.10 to the dollar and the domestic yuan to slide to 6.45 in the third quarter.
Nikko Asset Management shares a similar vision to Lombard.
“The main driver of the dollar will be higher interest rates, but the problem is that a large part is already incorporated into the markets,” said John Vail, the firm’s chief global strategist in Tokyo. “There is a strong dollar ahead, but don’t expect it to be spectacular.”
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