For all the hand-wringing by Federal Reserve officials over the strengthening dollar, foreign-exchange traders are signalling the currency’s two-year ascent is running out of steam.
Hedge funds have cut wagers on the greenback to the least since July 2014 as the dollar dropped to the lowest level last week in more than four months. Forecasters have followed, cutting their estimates for the currency.
The shifts are giving Fed policy makers their clearest signal yet that they have scope to map out another interest-rate increase this year.
“It enables the Fed to execute further tightening,” said Jennifer Vail, head of fixed-income research in Portland, Oregon, at US Bank Wealth Management, which oversees $125bn. “I don’t think the dollar’s a concern.” Vail said she favours the dollar versus the euro heading into policy makers’ meeting. The push-pull of the dollar on the Fed, where a stronger currency erodes impetus for officials to raise rates by tightening financial conditions, and a weaker currency does the reverse, is tipping in favour of higher rates in 2016.
The slumping greenback is rewarding central bankers who’ve stuck with plans to raise rates gradually, even after a trade-weighted measure of the US currency touched a 13-year high in January. Futures show a 78% probability of a rate increase by year-end, up from 30% odds a month ago.
The Bloomberg Dollar Spot Index, which tracks the US currency versus 10 peers, has fallen 1.9% this year. The central bank’s broad trade-weighted measure of the greenback tumbled 1.5% in the first week of March, the most in a year, taking the gauge down about 4% from the January high.
Large speculators reduced positions that profit from gains by the dollar against eight major peers to a net 112,848 contracts in the week through March 8, the least since July 2014 and down from 428,298 contracts in November, data from the Commodity Futures Trading Commission show.
Median forecasts compiled by Bloomberg show analysts expect an Intercontinental Exchange gauge of the greenback, which tracks the currency versus six major peers, to advance to 98.1 by December 31, from 96.6 yesterday.
The dollar’s appreciation has captured the Fed’s attention, particularly as it relates to inflation.
Policy makers discussed the strength of the greenback at all eight of their meetings during the past 12 months, with consideration seemingly peaking in September, when the central bank’s minutes mentioned the currency more than 20 times.
The prices for goods and services that consumers buy, excluding food and fuel, rose 1.7% from a year earlier in January, exceeding the Fed’s forecast of 1.6% for the end of 2016, a report showed February 26. Their goal of 2% inflation is back in reach with Fed Vice Chairman Stanley Fischer saying last week that “we’re not that far away,” and that inflation will rise after the dollar and oil stabilise.
“What we’re seeing in the dollar, what we’re seeing in oil, actually emboldens them in terms of telling the markets ‘We told you so’” on inflation, said Paresh Upadhyaya, director of currency strategy in Boston at Pioneer Investments, which oversees about $236bn and is betting on dollar gains. “The market is underestimating the Fed tightening cycle.”
The Bloomberg US Financial Conditions Index, which tracks financial-market stress, turned positive last week for the first time this year, boosted by a rally in stocks and corporate credit.
Rate increases are back in the cards this year as a result. While Morgan Stanley sees the US central bank waiting until December to move, futures show traders pricing in a 52% probability of an increase in June, up from just 6% a month ago.