"The dollar has become a beast again"! The dollar has rebounded alarmingly in the past two months, and we are wary of the Federal Reserve's "eagle" detonating the next wave of dollar gains

The dollar has rallied spectacularly since July, having risen sharply against almost every major currency in the past two months. Dollar bears have been caught off guard by the surprising resilience of the US economy and the persistent inflation that has followed.

In fact, at the end of 2022, many economists had predicted that the Federal Reserve could enter recession-fighting mode by cutting interest rates to kick-start the recovery. Instead, the U.S. economy is still growing strongly even as growth abroad shows signs of stalling. That has prompted investors to move money to the U.S., where interest rates are expected to remain high and stocks are supported by expectations that the Fed will end its rate hike cycle with the economy largely intact.

The combination of these two factors has pushed the Bloomberg Dollar Spot Index back near its high for the year after a record eight-week rise that began in mid-July.

The ICE Dollar Index also rebounded strongly after falling below the 100 mark, and is currently standing at the 105.00 mark.

(ICE Dollar Index Weekly Chart)

"The dollar is a beast again," says Mark Nash, a fund manager at Jupiter Asset Management, the UK asset management giant, who abandoned his bearish view in June.

At times, the dollar falls on weaker-than-expected data, but then reverses after a few hours. Nash believes that this is a clear signal that the trend of the dollar reflects the weakening of the growth outlook in the rest of the world.

"The US growth story is strong and the rest of the world has been weak," he said. "If the Fed manages to contain inflation and the US economy continues to grow, the dollar will remain strong."

So far, the dollar index remains below last year's peak, making the impact much smaller than in 2022, when a sharp rise in the dollar pushed up the cost of commodities such as oil, which are priced in dollars, adding to global inflationary pressures.

But with little confidence that the momentum behind the dollar's recent rise will soon reverse, analysts have been abandoning their bearish views on the greenback.

Charles Diebel, head of fixed income at Mediolanum International Funds, thought the dollar would weaken after 2023 but shifted to a neutral stance around mid-year as the US economy continued to perform well.

"If you put a gun to my head, I'm probably still leaning towards a weaker dollar for the next six to 12 months," says Mr. Diebel. "But in the next three months, I'm not so sure. The dollar could strengthen further."

Differences in growth prospects

Newton Investment Management Ltd. is one of the investors who have become bullish on the dollar in recent months. Trevor Holder, a fund manager at Newton Investment, said in an interview last week: "We are long the dollar because of the difference in growth."

Audrey Childe-Freeman, chief G10 FX strategist at Bloomberg Intelligence, said the cyclical bullish driver of the dollar that dominated in 2022 is back this summer, with the relative resilience of the U.S. economy contrasting with the euro's underperformance.

Kit Juckes, strategist at Societe Generale (601166), said that the different growth prospects are driving the market more than interest rates themselves. He pointed out that the euro is still falling despite the ECB's interest rate hike last week, which he attributed to the ECB's more pessimistic outlook for economic growth.

"The only positive thing I can think of for the euro and sterling is that expectations for UK and eurozone growth are already poor relative to the US," Juckes wrote in a note to clients.

In Japan, Deputy Finance Minister for International Affairs Masato Kanda said the government was ready to intervene in the market again if the yen depreciated further.

Dollar bulls hope the Fed will "eagle"

Investors face a closely watched decision on interest rates from the Federal Reserve on Wednesday, when the central bank is widely expected to keep policy on hold, with more focus on the so-called "dot plot" of interest rates and a press conference by Fed Chairperson Jerome Powell.

At 02:00 Hong Kong time on Thursday, the Federal Reserve will release a summary of interest rate decisions and economic expectations; at 02:30 Hong Kong time on Thursday, Federal Reserve Chairperson Powell will hold a monetary policy press conference.

At the end of August, Federal Reserve Chairperson Jerome Powell said at the central bank's annual meeting in Jackson Hole that he was prepared to raise interest rates further if the circumstances were right and intended to maintain monetary policy at a restrictive level until he was confident that inflation was falling steadily towards the target.

It is worth noting that hedge funds are bullish on the dollar for the first time since March, due to growing speculation that Federal Reserve policymakers will maintain their hawkish leanings at this week's meeting.

Data from the US Commodity Futures Trading Commission (CFTC) showed that the number of net long dollar positions held by leveraged funds and other major players reached 18,000 contracts in the week to September 12, compared with 25,175 net short positions in the previous week. Such a big shift was largely due to the biggest drop in long euro positions since January, as traders bet that the European Central Bank was about to end its rate hike cycle.

Win Thin, global head of currency strategy at Brown Brothers Harriman & Co., wrote in a client note: "With U.S. economic data remaining relatively strong, we believe the dollar rally will continue. We expect the Fed to take a hawkish stance this week, opening the door to further monetary tightening."

US retail sales rose 0.6 per cent month-on-month in August, beating expectations of a 0.2 per cent rise, driven by higher petrol prices, according to figures released on Thursday, the fifth straight month of growth.

The US producer price index rose 0.7 per cent month-on-month in August, beating expectations of a 0.4 per cent rise after Wednesday's report that consumer prices rose 0.6 per cent, the biggest gain in 14 months.   [Risk Warning] According to the relevant regulations on foreign exchange management, the buying and selling of foreign exchange should be carried out in the trading venues stipulated by banks and other countries. Private buying and selling of foreign exchange, disguised buying and selling of foreign exchange, scalping of foreign exchange or illegal introduction