Money managers are sounding a warning on the bullish dollar thesis that no one seems to be betting against.
Bank of America Merrill Lynch’s global fund manager survey published Monday found that investors think “long US dollar” is the most crowded trade right now.
The downside of a crowded trade is that if too many investors are betting on a particular outcome, things could get volatile when the consensus changes.
Bank of America also found that the share of managers who say the dollar is overvalued is at the third-highest level in the past ten years.
Bets on a higher dollar are being driven, in part, by the expectation for higher interest rates in the US. The Federal Reserve is widely expected to raise its benchmark rate again on Wednesday.
Although the dollar is expected to benefit when interest rates rise, it does not always play out that way. The chart below, shared by DoubleLine Funds founder Jeff Gundlach, shows that the Fed’s trade-weighted dollar, which compares the greenback to a broad basket of trading partners’ currencies, has dropped half of the time after the Fed entered a hiking cycle since 1986.
This time, however, it has gained since the Fed hiked in 2015 for the first time after the Great Recession, suggesting that the conventional relationship may continue to hold.
But there’s reason to be cautious on the dollar heading into 2017. HSBC’s currency strategists said in their 2017 outlook that restrictive trade policies would be negative for US economic growth and, by extension, the dollar.
President-elect Donald Trump’s fiscal policy stimulus is expected to benefit the dollar. Even though any accompanying rise in inflation would diminish the dollar’s strength and spending power, higher interest rates could counter that and support the currency.
And so, it’s little wonder why going long the dollar is the most popular trade on Wall Street right now. But that conviction is not enough to leave money managers worried that it could implode.
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