Hedge funds embrace dollar’s rally as U.S. economy boosts greenback

Hedge funds have abandoned their bearish positions on the dollar as the unexpected strength of the U.S. economy fuels a resurgence of the greenback. The U.S. dollar has climbed nearly three percent this year, causing losses for speculators betting on a decline.

Citibank, a leading global foreign exchange trading bank, reported that hedge funds have shifted from anticipating a decline to wagering on the dollar’s appreciation.

According to Citi, funds have “eliminated all their short U.S. dollar exposure collectively,” with their long positions now exceeding 80 percent of their maximum exposure over the past year. Previously, they held smaller negative positions as investors braced for a swift series of interest rate cuts by the Federal Reserve.

“The consensus view of dollar weakness coming into the year was wrong and people have flipped their positions,” said Sam Hewson, head of F.X. sales at Citi, as quoted by Financial Times, adding that a lot of hedge funds had been forced to cover their shorts as “the early 2024 playbook was adjusted.”

Defying rate cut expectations

The dollar’s surge was propelled by robust economic data such as impressive job numbers last week. The data further dashed hopes of a significant decline in borrowing rates in the world’s largest economy.

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Federal Reserve officials have also resisted market expectations of numerous rate cuts this year. During an interview on CBS’s 60 Minutes aired on Sunday, Fed Chair Jay Powell expressed his anticipation of approximately three quarter-point rate cuts in the year.

Markets, however, are pricing in four or five rate reductions, down from six or seven late last year. F.X. strategists at JPMorgan, another major foreign exchange trading bank, revealed that short positions on the dollar in futures markets have now been “neutralized.”

“There’s a substantial amount of U.S. growth exceptionalism relative to China and Europe and that just isn’t going away,” said Meera Chandan, co-head of global F.X. strategy at JPMorgan.

Chandan added that the euro could fall to parity with the dollar this year from its current level of $1.077.

JPMorgan anticipates that the dollar index, which measures the currency’s strength against a basket of rivals, will climb from its current level of 104 to between 106 and 108. The rise is expected by the end of June, propelled by the relative robustness of the U.S. economy.

Dollar strength prediction

Last week, the IMF increased its 2024 growth projection for the U.S. to 2.1 percent, up from the previous forecast of 1.5 percent in October. Meanwhile, for the euro area, it reduced its growth projection to 0.9 percent from 1.2 percent.

JPMorgan economists forecast that the Fed will cut rates for the first time in June, later than more than half of central banks globally.

“If the Fed was the only game in town, that’s when the dollar would be weakening quite a bit, but that’s not the case,” Chandan said.

The possibility of a Donald Trump victory in this year’s presidential election, particularly his commitment to imposing tariffs on imports to the U.S., could also bolster the dollar.

Chandan noted that tariffs would likely dampen the economic growth of U.S. trading partners, causing their currencies to weaken against the greenback.

These predictions of a strengthening dollar followed last week’s surprise for investors when official figures revealed that the U.S. economy had added 353,000 jobs in January, nearly double the forecast.

“The market [previously] had a tendency to shrug off some of the better economic data as being an anomaly,” said Jane Foley, head of F.X. strategy at Rabobank. “The payrolls data last week was so strong [that it] was impossible to shrug off. The market couldn’t avoid the assumption that the U.S. economy is going to be stronger for longer.”

Despite the recent repositioning, some analysts believe that a decline in the dollar has simply been postponed. According to Athanasios Vamvakidis, global head of G10 FX strategy at Bank of America, investors prematurely anticipated aggressive Fed cuts late last year, and a correction of that sentiment has driven this year’s surge.