The US dollar rally is running into a major problem.
It’s had an incredible run, but according to Citi’s Steven Englander, who heads up G10 FX strategy, investors are getting sceptical about increasing their long positions, or bets the dollar will rise.
“Right now positions, data flow and policy comments are working against USD, so even committed longs are trimming long USD positions. Given these factors, the long USD trade is looking very stale right now to many investors and that is weighing on USD. We remain optimistic that the policy divergence trade will reassert itself, but the timing is less certain and the USD remains vulnerable.”
The “policy divergence trade” is what’s driven the dollar higher, as markets anticipate the Federal Reserve raising interest rates soon while other central banks are committing to lower rates for a longer period. Higher rates make dollar-denominated assets more attractive.
Englander notes that Citi’s data show that many investors are still holding US dollars, so there isn’t a sell off quite yet. But these four things are giving investors pause about increasing their positions:
- Markets are ignoring news that would have driven the dollar even higher two or three months ago. Outside the US, selling currencies on bad news is no longer as popular as it used to be. The Australian dollar held up after weak Chinese data, and weak inflation data out of Sweden did little damage to the currency.
- US economic data is missing expectations more than it’s beating expectations. Retail sales, housing starts and initial claims all missed this week. Citi’s index of US data outcomes is at the lowest level since last July.
- Some Fed officials have made really dovish comments recently, indicating that rates may still be low for a while, and investors are paying more attention to them.
- Foreign central banks that are keeping rates low, fuelling the divergence trade, also seem to be shifting their positions. The Bank of Canada held its benchmark interest rate unchanged, noting that the impact of the oil crash on the economy is fading.
Investors will need to see some of these change before increasing their bets the dollar will rise, Englander wrote.
On Thursday, the dollar index fell to the lowest level since last Wednesday.
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