Hedge funds are increasingly downbeat on the dollar as the prospect of a two-week ceasefire extension between the US and Iran sap the currency’s war-driven strength.
Investors added to their bearish dollar trades this month through April 10, based on a proprietary trading model from Morgan Stanley.
In the options market, so-called risk reversals on the Bloomberg dollar index show the premium to hedge against a stronger dollar compared with bets against a weaker greenback has narrowed this month, to levels last seen on Feb. 27. Options pricing also indicates a shift in the past few days in tactical dollar positioning to roughly neutral levels from the most bullish in more than a year just last month, according to a Goldman Sachs note dated April 15.
“From what we’re seeing, the hedge fund community is using choppy conditions to fade the dollar, selling into strength rather than buying dips,” said Ivan Stamenovic, head of Asia Pacific Group-of-10 currency trading at Bank of America Corp. in Hong Kong.
The dollar’s turnaround has been swift. Bloomberg’s dollar index jumped 2.4% in March, its biggest monthly gain since July, as haven demand during the Middle East conflict bolstered demand for the world’s reserve currency.
The gauge has since dropped 1.9% in April —- including an eight-day losing streak through Wednesday — as the US and Iran started to discuss a resolution to the six-week old conflict. The eight-day slump was the longest since June 2020. It inched slightly lower at the start of Thursday’s trading.
“The path to a weaker dollar is widening, not narrowing,” Morgan Stanley analysts Molly Nickolin, David Adams and Andrew Watrous wrote in a research report published Tuesday.
“A ceasefire may be positive for risk currencies in the near-term, but we think medium-term dollar weakness may be more concentrated versus major peers,” such as the euro, yen, Swiss franc, they said.
The argument for more weakness is shared by a growing number of dollar watchers, including Kenneth Rogoff, who said that the greenback was “probably at least still 20% overvalued,” and was at risk of a long-term correction as a result.
In an interview with Bloomberg TV, the former chief economist at the International Monetary Fund added that the war may accelerate movements by Europe and other regions to become “more independent of the dollar.”
Pressure to sell the greenback began building last week after an initial two-week ceasefire was announced, triggering the biggest one-day decline in the Bloomberg dollar index in more than two months.
“The hedge fund community had been waiting to sell the dollar, and the first ceasefire proved the catalyst,” said Antony Foster, head of Group-of-10 spot trading at Nomura International Plc in London.
“It was one of the heaviest dollar sell days I’ve seen in a while, across most G-10 pairs in cash and options,” referring to the April 8 trading.
Trading in euro-dollar call options of €100 million ($118 million) or more was 50% bigger than that of puts on Tuesday and Wednesday, according to data from the Depository Trust & Clearing Corp. Call options profit from euro gains, while put options rise if the dollar strengthens.
“In the near term, we’re seeing fast-money accounts buying euro upside via relatively cheap option structures,” said Richard Oliver, global head of FX cash at HSBC Holdings Plc in London. “Modest de-dollarization is becoming an increasingly important medium-term theme.”
Bearish Bets
Asset manager SGMC Capital Pte in Singapore was among those who took advantage of the dollar’s gain in March to add bearish bets, according to chief executive officer Massimiliano Bondurri.
“We have been using the recent dollar strength to gradually add to bearish positions, as we expect any eventual de-escalation to weaken the greenback,” he said.
There’s scope for further dollar declines if a more durable truce is reached, Bondurri said, identifying preferred trades including selling the US currency against the Australian dollar, Mexican peso and Brazilian real.
“FX flows have been consistent with asset managers who are quick to reduce risk and buy dollar at the start of the war, but now starting to look through it,” said Jerry Minier, global head of linear G-10 FX trading at Citigroup in London. “Many managers acknowledge that once peace is made the underlying dynamics driving a weaker dollar will return. Recent dollar weakness reflects that shift in narrative.”
Worse Off
While there’s still uncertainty over how long the US-Iran war will last, there are increasing prospects that it may end up doing more harm than good to the dollar.
“Net-net, the dollar appears to be emerging worse-off from the conflict,” JPMorgan Chase & Co. analysts wrote in a client note published last week. In the medium term, the greenback might “make another run toward the year’s lows,” they said.
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