Can't guess the Federal Reserve! Hedge funds: shorting the dollar is too dangerous!

The dollar's recent strength has puzzled some skeptics, while some hedge funds believe the rally is not over yet.

K2 Asset Management said the dollar would continue to rise as US interest rates remained high, and AVM Capital expects rising Treasury yields to push the greenback further.

“It seems too risky to short the dollar", said George Boubouras, head of research at K2, who believes the dollar will strengthen against the Australian dollar and other currencies affected by risk sentiment." The theme of keeping the federal funds rate high for a long time will dominate the market, and we believe the market will start pricing in multiple 2024 rate cuts that will fail. "

The dollar's seven-week rally has forced dollar bears to reassess their bets, as a series of positive US economic data undercut the case for monetary easing. Hedge funds have been among those caught off guard by the dollar's strength, having been betting on a weaker currency since June.

The Bloomberg Spot Dollar Index is heading for its eighth straight week of gains, which would be the longest streak of gains since data began in 2005. Signs that the US economy is on the verge of a soft landing strengthen bets that the Federal Reserve will maintain higher interest rates for longer, which will enhance the attractiveness of the dollar.

That could be a problem for dollar bears. BNP Paribas Asset Management forecast in July that the dollar would remain weak in the coming months, while Standard Bank predicted it would enter a "multi-year downtrend" as the Federal Reserve begins to ease policy. Traders are pricing in a 75-basis point rate cut between January and the end of the third quarter.

There are other factors that could continue to drive the dollar higher: Weaker economic growth momentum elsewhere could stimulate demand for safe-haven assets, while other major currencies such as the euro are expected to remain under pressure due to sluggish growth.The euro has fallen 5 per cent since its July high. The yen has fallen more than 5 per cent in the past quarter, a victim of the widening interest rate differential between Japan and the US.

Marko Papic, chief strategist at Clocktower, sees himself as a long-term short on the dollar, but for now sees room for further tactical bounce. He sees the Fed as "significantly behind the regular curve" in 2024 and "the idea of the Fed hitting its 2 per cent inflation target before the election is a fairy tale to me".

Some people have a different point of view.

Audrey Childe-Freeman, head of FX strategy at Bloomberg G10, said that the cyclical bullish dollar factor that dominated 2022 returned this summer, with the relative economic resilience of the United States in sharp contrast to the poor performance of the euro. But the upcoming Fed interest rate peak narrative is still valid, which means that yield-driven dollar gains may be a thing of the past.

Great Hill Capital is buying stocks that will benefit from a weaker dollar, including riskier emerging market stocks, on the idea that the dollar's rally is coming to an end as the Federal Reserve ends its tightening cycle in the coming months.

Similarly, Jun Bei Liu of Tribeca Investment Partners thinks the dollar's rally may be over for now. "U.S. interest rates have basically peaked," he says. "From now on, the dollar no longer seems to be a safe-haven currency or a leverage tool linked to rising interest rates."

But for now,Industrial foreign exchangeWe looked at the data.The rise in U.S. Treasury yields is driving the dollar stronger, especially after the benchmark 10-year yield surged to a 16-year high last month. US Treasury yields are likely to remain high as some Federal Reserve officials signal reluctance to end the rate hike cycle and as a lot of debt issuance pressure weighs on the market.

"We expect a broad-based rally in the dollar over the next few months as bond yields rise and financial conditions continue to tighten," said Ashvin Murthy, chief investment officer at AVM Capital Pte hedge fund in Singapore.