Analysis-Dollar endures swings on global yields, rise will play off US currency weakness By Reuters

By Saqib Iqbal Ahmed

NEW YORK (Reuters) – Traders weighing how best to play a sliding U.S. dollar are watching the relative strength of economies around the world as interest rate cuts from global central banks roil currency markets.

In the third quarter of 2024, it fell 4.8% against a basket of currencies, its worst quarterly performance in nearly two years. Pressure on the US currency increased after the Fed last month offered a 50 basis point rate cut, its first rate cut since 2020.

How much the dollar will fall and which currencies will benefit may be largely a matter of yields. For years, US yields have been above most developed economies, strengthening the greenback’s appeal against its peers.

That picture is now changing, with the Fed and most other central banks cutting interest rates to protect economic growth. Many traders who bet against the dollar do so through currencies whose yield differential against the dollar is expected to narrow.

Net bets on a weaker dollar rose to $14.1 billion in futures markets, the highest level in about a year, Commodity Futures Trading Commission data showed. The path down for the dollar, however, is likely to be a bumpy one.

The still-strong U.S. economy could limit how much the Fed cuts interest rates, complicating the outlook for further dollar declines. Meanwhile, the US presidential election threatens to inject volatility into currency markets in the coming weeks.

“It’s not necessarily about selling the dollar and buying everything,” said Jack McIntyre, portfolio manager at Brandywine Global. “You have to be a little more selective.”

While flat for the year, it was down about 5% from its April high, with the currency falling against several developed-market peers as US yields fell in anticipation of the Fed’s easing of monetary policy.

Economic data can be a catalyst for big moves in the coming days.

Eurozone inflation fell below 2% for the first time since mid-2021 in September, strengthening the case for the European Central Bank to cut rates this month, a potential source of weakness for the euro.

On the US side, Friday’s labor market data could help shape views on how much the Fed might cut interest rates for the rest of the year.

Although futures markets still point to 70 basis points of price cuts, a strong number could support the case for more moderate policy easing. However, “If we’re going into a weak period for the US economy, the market is going to cut more of the curve and that’s going to weaken the dollar,” said Christian Dery, head of macro strategy at Capital Fund Management.

Paresh Upadhyaya, head of currency and fixed income strategy at Amundi US, said he was looking for “idiosyncratic stories like the widening of interest rate differentials caused by a divergence in monetary policy.”

Its plays on a weaker dollar include positions in the Norwegian krone and the Australian dollar. Norway’s central bank recently kept its policy interest rate at a 16-year high, signaling that any cut must wait until early 2025. Australia’s central bank kept interest rates steady last week and said cuts interest rates are unlikely in the short term.

Upadhyaya also added to a position in the Brazilian real. Unlike many of its peers, Brazil’s central bank raised interest rates last month as it tries to deal with a challenging inflation outlook. The Brazilian real has fallen about 10% against the dollar this year.

The Japanese yen could also find further support from the central bank’s divergent policy, investors said. The Bank of Japan tightened interest rates to 0.25 percent in July, in a landmark shift from a decade-long stimulus program aimed at spurring economic growth.

Although the Bank of Japan has signaled it is in no rush to raise rates further, the narrowing gap between Japanese and US rates has already fueled a 13% rally in the yen from 2024 lows against the dollar. Net bullish bets on the currency against the dollar totaled $5.8 billion, CFTC data showed.

“With global central banks also starting to cut rates, the biggest gain against the USD will be in the (yen),” said Natsumi Matsuba, head of FX trading and portfolio management at Russell Investments.

An analysis of currency valuations based on parameters such as purchasing power parity and effective real exchange rates, published by BofA Global Research last month, showed that the yen and Norwegian krone are among the developed world’s most undervalued currencies. The dollar and the Swiss franc are the two most overvalued, the study found.

Whatever their positioning, however, investors must also contend with potential volatility surrounding the US presidential election, scheduled for November 5.

Uncertainty in the weeks leading up to the vote could boost the dollar, a popular haven. Many investors also believe that a victory by Republican candidate Donald Trump could support the dollar.

“The wild card in any forecast right now for our currency is the U.S. election,” said Brandywine’s McIntyre, which remains bearish against the U.S. dollar but less so than before the currency’s recent slide. “That’s why it’s hard to be super convicted.”