May 18, 2023

Some of the world’s top investors are betting that the worst will come in an eruption U.S. dollar It ended after the boom upended the global economy in a way that has few parallels in recent history. After the dollar jumped to generational highs last year – exponentially exacerbating poverty and inflation from Pakistan to Egypt, Lebanon, Ghana and more – the dollar has now entered what some forecasters call the beginning of a multi-year decline.

Has the nightmare of the dollar’s rise finally ended?

American investors and economists say to the American Bloomberg Network that the dollar is on its way to decline. Because the bulk of the Fed’s rate increases are over, and practically every other currency will be strengthening as central banks continue to tighten.

While recent data has led traders to rethink rising US interest rates, the shift to risky assets from equities to emerging markets is already on bets that the dollar’s strength will wane. Many investors are holding on to these bets, even after the dollar recently recovered its losses for the year.

“The peak dollar is definitely behind us.”

“The peak of the dollar is definitely behind us, and a structurally weaker dollar awaits us,” Georges Poporas, market expert and head of research at hedge fund K2 Asset Management, told Bloomberg. He added, “Yes, inflation in the United States is stubborn, and yes, interest rates indicate higher rates in the United States, but this does not negate the fact that other economies in the world are catching up with the United States.”

A stronger-than-expected reading in a key US inflation measure yesterday, Friday, February 24th, showed just how painful the strength of the US dollar could be. The dollar rose near year-to-date highs, while riskier assets such as emerging market currencies and stocks in general fell. The Australian dollar and the Japanese yen fell more than 1%.

What does the dollar’s decline mean for other economies?

The relief that a weaker dollar will bring to the global economy cannot be overstated. Import prices for developing countries will fall, which helps reduce global inflation. It is also likely to boost the price of everything from gold to stocks and cryptocurrencies.

That may help mitigate some of the damage done in 2022, when the strong dollar left a trail of devastation in its wake: inflation soared as the cost of food and oil rose, pushing countries like Ghana to the brink of default, while stock and bond investors suffered huge losses.

The strength of the US currency is set to wane with the Fed’s yield premium; Other central banks are showing similar determination in slowing price growth. Policy makers in the Eurozone and Australia indicate that further rate hikes are needed to beat inflation, while speculation mounts that the Bank of Japan will abandon its ultra-loose stance this year.

The data shows that US borrowing costs are likely to peak in July, and a rate cut could come as early as the Fed’s first review in 2024; The price gains are due to the US central bank’s target.

But some see inflation as still a concern

These bets are evident in the dollar’s movements, as the Bloomberg Spot Dollar Index is down about 8% since its record high in September. In parallel, investors bought emerging market bonds and stocks at the fastest pace in nearly two years last month.

Some market participants argue that the Fed chooses modest rate hikes based on expectations of easing price pressures. This view is somewhat at odds with the US central bank’s assessment that inflation remains a concern and further increases are needed to bring it down to the 2% target.

“There is still a lot of Fed tightening in the system that hasn’t worked its way out yet,” said Eric Stein, chief investment officer at investment management firm Morgan Stanley. At the Fed they say they will raise inflation to 2%, but in reality I say they will go further to 3%. I don’t think they’re going to keep raising interest rates to 6% just because of that.”

Other currencies breathe a sigh of relief

All of this means that currencies that have suffered under the weight of the dollar’s strength are likely to get stronger. The yen has already gained more than 12% against the dollar since falling to a 3-decade low in October, and strategists polled by Bloomberg think the yen could rise another 9% by the end of the year.

The Euro is up around 11% from its September low, while the Dollar has lost ground against most of its G10 peers in the past three months. The Bloomberg JPMorgan Asian Dollar Index has advanced more than 5% since hitting its lowest level in October.

Some investors are already testing the theory that the dollar’s dominance is over. Global investment firm Abrdn switched to dollar-neutral late last year, while asset management group Jupiter is selling the greenback outright.

K2 Asset Management has pulled back from its long dollar exposure since October, and it expects commodity currencies such as the Canadian dollar and the Australian dollar to outperform this year. Likewise, hedge funds’ bearish bets against the dollar swelled to their highest levels since August 2021 in early January, and JPMorgan Asset Management expects the yen and the euro to advance further.

Some investors like James Athey of Abrdn Investments are waiting before making the next bearish move on the greenback. He is waiting for the “last phase of risk aversion,” a scenario in which realization of the weak global outlook will trigger a new bout of dollar demand.

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