
Analysis: Dollar Bears Monitor Shifts in Global Yields and Growth Impacting Weakening US Currency By Reuters
By Saqib Iqbal Ahmed
Traders are currently assessing how to navigate the declining U.S. dollar as they analyze the relative strength of global economies amid rate cuts from central banks, which are reshaping currency markets.
In the third quarter of 2024, the U.S. dollar experienced its worst quarterly performance in nearly two years, falling 4.8% against a basket of currencies. This decline accelerated following the Federal Reserve’s significant 50 basis point rate cut last month, marking its first reduction since 2020.
The extent of the dollar’s decline and the currencies that may benefit from it largely depend on interest yields. Historically, U.S. yields have surpassed those of most developed economies, which boosted the dollar’s appeal. However, as the Fed and many other central banks implement rate cuts to support economic growth, this landscape is beginning to change.
Traders betting against the dollar are increasingly focusing on currencies with yield gaps expected to narrow against the dollar. Recent data from the Commodity Futures Trading Commission showed that net bets on a weaker dollar have surged to $14.1 billion in futures markets, the highest level in about a year. However, the dollar’s path downward may be uncertain.
The resilient U.S. economy could limit the extent of further rate cuts by the Fed, complicating predictions for the dollar’s movement. Additionally, the upcoming U.S. presidential election is likely to introduce volatility into the currency markets.
"It’s not merely about ‘selling the dollar and buying everything,’" said Jack McIntyre, a portfolio manager at Brandywine Global. "You need to be more discerning."
While the dollar remains stable year-to-date, it has decreased approximately 5% since its peak in April, showing declines against several developed market currencies as U.S. yields fell in anticipation of easing monetary policy.
Economic indicators could drive significant movements in the currency markets soon. In September, inflation in the Eurozone dropped below 2% for the first time since mid-2021, strengthening the case for a European Central Bank rate cut this month, which may weaken the euro.
On the U.S. front, labor market data released Friday will be crucial in determining future Fed rate cuts. Futures markets currently forecast an additional 70 basis points of cuts, but a strong labor report could support a more cautious approach to policy easing. Conversely, if the U.S. economy enters a downturn, the markets will likely price in further cuts, diminishing the dollar’s value, according to Christian Dery, head of macro strategy at Capital Fund Management.
Paresh Upadhyaya, director of fixed-income and currency strategy at Amundi US, is targeting "individual narratives like widening interest rate differentials driven by shifts in monetary policy." His strategy includes investments in the Norwegian krone and Australian dollar. Norway’s central bank recently kept interest rates at a 16-year high, indicating that cuts are not expected until early 2025. Meanwhile, Australia’s central bank maintained steady rates, suggesting that rate cuts are unlikely soon.
Upadhyaya has also taken a position in the Brazilian real, which has decreased around 10% against the dollar this year despite the Brazilian central bank raising rates last month to address inflation concerns.
The Japanese yen may also gain traction from divergent central bank policies. The Bank of Japan raised rates to 0.25% in July, signaling a departure from its long-standing stimulus policy aimed at boosting economic growth. Although the Bank of Japan is not in a rush to increase rates further, the narrowing interest rate gap between Japan and the U.S. contributed to a 13% rally in the yen from its 2024 lows against the dollar. Current data reveals net bullish bets on the yen against the dollar at $5.8 billion.
"With global central banks beginning to cut rates, the yen is poised to be a significant beneficiary against the USD," stated Natsumi Matsuba, head of FX trading and portfolio management at Russell Investments.
A recent analysis of currency valuations by BofA Global Research indicated that the yen and Norwegian krone are among the most undervalued currencies in the developed world, while the dollar and Swiss franc are the most overvalued.
Despite varied positions, investors should be wary of potential volatility leading up to the U.S. presidential election scheduled for November 5. The uncertainty surrounding the election could enhance the dollar’s appeal as a safe-haven asset. Furthermore, many investors speculate that a victory for Republican candidate Donald Trump could strengthen the dollar.
"The unpredictable factor for our currency outlook right now is the U.S. election," said Brandywine’s McIntyre, who is cautious about the dollar’s future yet less so than prior to its recent decline. "That’s what makes it challenging to hold strong convictions."