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U.S. dollar – When will bulls turn to bears?

Trump wants it to be cheaper. The IMF says it should be cheaper. Hedge funds think it has room to run. So what gives with the dollar?

Since the trade war between the world’s two largest economies erupted in March last year, the dollar has gained more than 3 percent against a basket of currencies.

The dollar’s strength, however, does not sit well with President Donald Trump, who has advocated for a weaker currency to make U.S. exports more competitive. On Monday, the U.S. Treasury labelled China a currency manipulator for allowing the yuan to weaken beyond a key level.

Trump feels that U.S. trading partners, the Chinese in particular, are all working frantically to keep their currencies cheap to gain an edge in trade.

His rhetoric has led to speculation that the U.S. government, through the Treasury, could intervene to weaken the dollar by using the Exchange Stabilization Fund. That is seen as unlikely. That fund has approximately $146 billion (£120 billion) in reserves, according to Bank of America Merrill Lynch, which may not be enough to have a significant impact in a more than $5 trillion currency market.

Trump is not the only one who believes the dollar should be weaker. The International Monetary Fund says the dollar ought to be about 6-12 percent cheaper based on near-term economic fundamentals, but structural issues such as the greenback’s position as the global reserve currency make that unlikely.

But week after week, hedge funds keep piling up bets that the dollar’s surge has further to run as the world appears headed toward a trade-induced pause in growth if not outright recession.

So who’s right? Here are the arguments:

BULLISH SCENARIO

Being bullish on the dollar has been a popular trade. Bank of America Merrill Lynch’s July fund manager survey showed the dollar was the fourth most crowded trade with 49 percent of respondents saying it is overvalued. The speculative community has been net long dollars since mid June last year.

Bulls say the dollar could benefit from increasing trade tensions.

“It’s a safe haven and offers a very liquid store of value,” said Mazen Issa, senior FX strategist at TD Securities, who said there are very few alternatives to the dollar in the event of a full-scale trade war with China.

Foreign investors also tend to buy U.S. Treasuries as a safe haven hedge, analysts said.

Further enhancing the dollar’s and Treasuries’ appeal is the yield premium over their counterparts.

Seema Shah, chief strategist at Principal Global Investor, said that with more than 40 percent of non-U.S. bonds trading at negative yields, Treasuries have become high yielders.

BEARISH VIEW

While the trade tension has benefited the dollar as a safe haven, there is an argument that the trade stress could undermine the greenback because it would have an adverse impact on the U.S. economy.

Analysts said trade tensions could diminish business and consumer confidence as well as tighten financial conditions.

“We feel that the escalation in the trade war is a risk to the U.S. economy that would prompt the Fed to ease more,” said Richard Franulovich, head of FX strategy at Westpac in New York.

Interest rate futures implied traders fully expect the Fed to lower rates again at its policy meeting next month, after cutting rates last week for the first time in a decade, CME Group’s FedWatch showed on Tuesday.

“We’re starting to get to a point now where it seems that the more hostile the U.S.-China trade war becomes, the more bearish it’s becoming for the dollar, and of course we didn’t quite see that in the early days of the trade war,” said Bipan Rai, head of FX strategy at CIBC in Toronto.

Increasing U.S. debt could also weigh on the greenback, analysts have said.

Zhiwei Ren, portfolio manager at Penn Mutual Asset Management, said it is hard to envision a bullish scenario for the dollar at this point even though the U.S. economy has outperformed the rest of the world.

“The dollar has been strong for the last two to three years,” Ren said. “It’s very hard for one country to stay strong for too long.”
Source: Reuters (Reporting by Gertrude Chavez-Dreyfuss; additional reporting by Karen Brettell and April Joyner; editing by Megan Davies and Leslie Adler)

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