© Reuters. FILE PHOTO: Woman holds U.S. dollar banknotes in this illustration taken May 30, 2022. REUTERS/Dado Ruvic/Illustration/File Photo
By Jamie McGeever
ORLANDO, Florida (Reuters) – The rise in U.S. rate cut expectations for next year seems to have prompted hedge funds to cool their optimism on the dollar, potentially weakening a key plank of support for the currency in the coming months.
The latest Commodity Futures Trading Commission (CFTC) data shows that funds cut their net long dollar position against a range of major and emerging currencies to $4.5 billion in the week ending Nov. 14 from $10 billion the week before.
The $5.5 billion week-on-week swing is the biggest since July and second largest this year, and comes as interest rate futures markets had moved to price in up to 100 basis points of Fed rate cuts by the end of next year.
That dovishness has been tempered in recent days, but not by much. Traders have consistently underestimated the Fed’s resolve to keep rates elevated, but they are sticking to their guns and banking on hefty easing in the second half of next year.
If the latest CFTC figures are any indication, this has prompted hedge funds to put the brakes on their dollar-buying spree. Whether that’s a temporary pause or a more lasting move will depend on the Fed.
“Large USD weakness requires Fed cuts and better ex-US growth, but these conditions are not met yet,” JP Morgan’s currency strategy team wrote in their 2024 outlook.
Funds’ $10 billion net long dollar position in the week ending Nov. 7 was the biggest bullish bet on the greenback since October last year and a huge turnaround from the net short position worth more than $20 billion in mid-July.
This momentum suggested a base was being formed for another prolonged dollar upswing, and coincided with a 7% rise in the . But the dollar has slid 3% in November, which would be its worst month in a year.
THIS TIME IT’S DIFFERENT?
The last decade has shown that CFTC funds’ net dollar positions tend to be long-term, directional trades held for at least a year, the longest of which was the net long from May 2013 through June 2017.
But this time may be different – funds have only been net long dollars for nine weeks.
The long dollar liquidation in the week to Nov. 14 was mostly against the euro and Japanese yen.
Funds expanded their net long euro position by $2.9 billion, or nearly 21,000 contracts, the sixth increase in a row and the biggest since July. That position is now worth nearly $18 billion, the most in three months and well up from $11 billion only two weeks ago.
Funds cut their net short yen position by $2 billion, or almost 25,000 contracts, essentially reversing the previous week’s move which had pushed the overall net short yen position to the biggest in six years.
Positioning is still stretched, and if the Bank of Japan signals an end to negative interest rates sooner rather than later, the yen’s upside is potentially huge – it is languishing near a 33-year low against the dollar, a 15-year low against the euro, and a 50-year low on a real effective exchange rate basis.
“The clear exception to widespread USD strength is JPY, which ends up the broad-based outperformer: We see falling to 142 by mid-2024,” Morgan Stanley’s FX strategy team wrote in their 2024 outlook.
(The opinions expressed here are those of the author, a columnist for Reuters.)