"Dollar\u2019s extended reign delivers stark wake-up call for markets"

" Dollar\u2019s extended reign delivers stark wake-up call for markets \r\n\r\nThe world\u2019s financial markets are encountering a force they didn\u2019t bet on for 2024: A strong dollar is back and looks set to stay.\r\n\r\nHaving entered the year predicting the greenback would decline, investors have been forced into a rethink by a red-hot US economy and sticky inflation requiring the Federal Reserve to hold off cutting interest rates.\r\n\r\nWith the International Monetary Fund predicting output stateside will grow at twice the clip of its Group-of-Seven peers, talk of \u201cUS exceptionalism\u201d is rife and supporting stocks and bond yields, adding to the dollar\u2019s appeal. And in a time of mounting geopolitical strife, the currency still stands as the ultimate currency haven.\r\n\r\nA Bloomberg dollar index has gained more than 4% this year, reflecting advances against all major developed and emerging-market counterparts. One popular gauge of trader sentiment pointed bearish at the start of the year, but has since flipped to become the most bullish since 2019, according to data from the Commodity Futures Trading Commission.\r\n\r\nAmong those recalibrating their strategies for the dollar is the world\u2019s second-biggest money manager Vanguard Group Inc., which is now calling for sustained strength. UBS Asset Management says the dollar has probably got further to rise despite being 20% more expensive than it\u2019s typically valued. Meantime, Wells Fargo Investment Institute capitulated on forecasts for weakness by year-end and now reckons it will extend its climb through 2025.\r\n\r\n\u201cIf other countries can\u2019t match the growth and inflation of the US, there\u2019s just no other option than to buy the dollar,\u201d said Ales Koutny, head of international rates at Vanguard. \u201cWhat was a very tactical trade for us before has become much more of a long-term structural view regarding sustained dollar and US economic strength.\u201d\r\n\r\nThe greenback\u2019s resurgence has come on the back of a slew of signs that the US economy swerved the slowdown many anticipated. The labor market has stayed tight and manufacturing activity continues to expand. The resulting persistence in inflation has led Fed Chair Jerome Powell and fellow policymakers to wait longer than expected to cut rates.\r\n\r\nNew York Fed President John Williams has even suggested the possibility of resuming rate hikes if warranted.\r\n\r\n\u201cAt the beginning of the year I was more of a dollar bear, but that\u2019s no longer the case,\u201d said Rajeev De Mello, global macro portfolio manager at Gama Asset Management SA. \u201cPowell\u2019s comments definitely changed things.\u201d\r\n\r\nOf course, the surge in the world\u2019s reserve currency inflicts a price on its counterparts and their economies, which traders are also scrambling to address. India and Nigeria are among the countries seeing their exchange rates plumb record lows, while threats of intervention are being heard from Japan to Poland.\r\n\r\nCentral banks in developed markets such as Australia, the euro-area and UK may find their room for lowering rates limited if weaker exchange rates fan domestic inflation. Those countries burdened by foreign debt, including the Maldives and Bolivia, as well as those heavily reliant on American imports, may be among the most hurt.\r\n\r\nIn a sign of growing anxiety caused by the greenback\u2019s rapid ascent, the Group of Seven nations earlier this month reaffirmed their common stance over the potential damage of disorderly currency moves. It came after US Treasury Secretary Janet Yellen acknowledged the concerns of Japan and South Korea over sharp declines in their currencies, which may offer Tokyo and Seoul more scope to defend the yen and won.\r\n\r\n High Yields \r\n\r\nAs markets scale back bets on Fed easing, Treasury yields have soared again in recent weeks, sending benchmark yields to near 5%. The surge has been a major driver of the dollar\u2019s appeal, which has also benefited from ceaseless inflows into US stocks amid the frenzy for artificial intelligence.\r\n\r\n\u201cWhat\u2019s unique now is that the dollar is such a high yielder,\u201d said Peter Vassallo, portfolio manager at BNP Paribas Asset Management. \u201cIf you\u2019re a global allocator and running your portfolio, what a slam dunk to improve your risk-adjusted returns: buy shorter-term US debt, unhedged.\u201d\r\n\r\nIn contrast to reduced expectations for Fed easing, European Central Bank President Christine Lagarde has indicated policymakers may be in a position to lower rates in June. Meantime, Japan is so far behind the US in growth that even a historic decision to end the world\u2019s last negative rates failed to prevent the yen from hitting a 34-year low.\r\n\r\n\u201cThe interest environment in the US is just so much more attractive,\u201d said Ed Al-Hussainy, global rates strategist at Columbia Threadneedle Investments. \u201cThe US dollar offers a very high rate of return.\u201d\r\n\r\n Haven Demand\u00a0 \r\n\r\nAnother tailwind for the dollar is its role as an unrivaled sanctuary for investors seeking refuge at times of political or financial turmoil. The currency\u2019s haven status was on full display Friday, surging after Israel launched a retaliatory strike on Iran less than a week after Tehran\u2019s rocket and drone barrage.\r\n\r\nHelping to explain the dollar\u2019s haven status is the widely-followed \u2018dollar smile\u2019 theory coined by Stephen Jen, chief executive of Eurizon SLJ Capital Ltd. Jen\u2019s thesis is that the dollar rises when the US economy is either booming or in a deep slump, with weakness during periods of moderate growth.\r\n\r\nHeightened geopolitical risks are working together with a booming economy to create \u201ca curlier smile, with steeper tails,\u201d creating more of a U-shape, Jen said in an interview. \u201cFor every level of US outperformance, the dollar should be stronger, because of that safe haven premium coming from geopolitical risk.\u201d\r\n\r\nUS growth hasn\u2019t decelerated so the dollar will stay on the \u201cright side\u201d of the smile for longer, he said.\r\n\r\n What Bloomberg Strategists Say...\u00a0 \r\n\r\nThe underlying strength of the greenback will linger as long as US exceptionalism and stubborn inflation persists.\r\n\r\n\u201cSo long as the US economy is stronger than its G7 brethren, the dollar will be strong relative to other G7 currencies,\u201d said University of California at Berkeley economist Barry Eichengreen. \u201c Not everyone may be happy with this, but there is little that can be done about it, \" - Mary Nicola, Markets Live strategist.\r\n\r\nThe author of \u201cExorbitant Privilege: The Rise and Fall of the Dollar\u201d doesn\u2019t expect strength in the US currency to lead to confrontations, but does see growing debt servicing difficulties for developing countries with dollar-denominated debts.\r\n\r\nBut to some observers, including Clocktower Group\u2019s Marko Papic, US currency strength may offer a \u201csilver lining\u201d for Europe, China and Japan. \u201cIt would help engender a global recovery given that most of the rest of the world is export oriented,\u201d said the alternative asset manager\u2019s chief strategist.\r\n\r\nWhile the escalating tensions in the Middle East offer a fresh boost to the dollar, its strength will likely last well beyond the conflict.\r\n\r\n\u201cI still expect the dollar will prove the ultimate winner as the knee-jerk reactions fade,\u201d said Carol Kong, a strategist at Commonwealth Bank of Australia, referring to the latest developments in the Middle East. \u201cUS energy independence and high yields are likely to keep the dollar\u2019s appeal to investors.\u201d"

"Dollar\u2019s extended reign delivers stark wake-up call for markets"

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