(Bloomberg News) Hedge funds and large speculators are abandoning bets on a stronger dollar at the fastest pace ever amid growing confidence in the global economy.
Futures contracts favoring gains in the U.S. currency surged to the most on record in June as growth faltered and investors retreated from risky assets. Now, hedge funds are reversing those bets as central banks from China to the U.S. vow to stimulate their economies, prompting money managers to seek higher returns from Sweden to Australia.
Traders have less need for the relative safety of assets denominated in dollars as the cost of insuring sovereign bonds for Group of 10 and other nations tumbles to the lowest level in a year and stocks reach the highest since 2008. Sweden's krona, backed by interest rates about six times those in the U.S., rose more than any other major currency in the past month. The dollar and the yen, havens in periods of turmoil, declined the most.
"We are seeing a recovery of risk appetite in financial markets across the board including foreign exchange," Ulrich Leuchtmann, head of currency strategy at Commerzbank AG in Frankfurt, said on Aug. 21. "People will try to diversify away from the dollar into currencies that have strong fundamentals like the Australian dollar and the Scandinavian currencies."
The Dollar Index, which tracks the euro, yen, pound, Canadian dollar, krona and Swiss franc, surged 16 percent from last year's low in May of 72.696 to this year's peak of 84.1 on July 24. It has since slipped 3 percent to 81.593 on Aug. 24. The U.S. currency weakened 1.4 percent last week against the euro to $1.2512 and depreciated 1.1 percent to 78.67 yen.
Net bets that the world's reserve currency will drop against eight major peers increased to 131,512 contracts as of Aug. 21, data from the Commodity Futures Trading Commission show. That compares with about 311,000 contracts betting on an advance on June 5, the biggest reversal on record.
The data tracks positions in the dollar against the euro, yen, pound, Australian dollar, Canadian dollar, New Zealand dollar, Swiss franc and Mexican peso.
The median estimate of more than 50 forecasters is for the dollar to appreciate to $1.21 per euro by year end. The U.S. currency will be little changed versus the yen, according to separate analyst predictions compiled by Bloomberg.
Rather than reflecting less optimism about the U.S., the shift in the futures contracts may show growing expectations that the Federal Reserve will increase efforts to stimulate the economy by pumping more cash into the banking system through purchases of bonds, known as quantitative easing, or QE.
The Dollar Index slumped as much as 19 percent to 72.696 from 89.624 as the Fed printed currency to buy $2.3 trillion of mortgage and Treasury debt in two rounds of QE from December 2008 to June 2011.
It also illustrates that the rest of the world is getting safer. The average cost of credit-default swaps insuring the debt of about 50 nations tracked by Bloomberg fell to 160 basis points, or 1.6 percentage points, on Aug. 24 from as high as 250 basis points in November.
Swaps tied to Spain dropped to 445 basis points this month from a record 647 on July 25, and those for Italy declined to 394 from this year's high of 580 on June 1.
Contracts on China reached the lowest in five months, while the U.S. fell to levels not seen since May, and Germany touched a 13-month low. The swaps rise when perceptions of creditworthiness deteriorate and fall when they improve.
People's Bank of China Governor Zhou Xiaochuan said on Aug. 22 that adjustments to interest rates and banks' reserve requirements are still possible, leaving the door open for further monetary stimulus.
Sentiment toward Europe improved after European Central Bank President Mario Draghi vowed on July 26 to do "whatever it takes" to defend the euro, helping to stem a slide that pushed the 17-nation currency down about 6 percent since late March against its major counterparts as the region's sovereign crisis intensified. Draghi's comments came after Spain and Cyprus joined Greece, Ireland and Portugal in seeking bailouts.
"The difficulties of Europe created one of the supports for the dollar early on in the year," Brian Kim, a currency strategist in Stamford, Connecticut, at Royal Bank of Scotland Group Plc, said in an Aug. 23 telephone interview. "You had the safe-haven demand. You could now see some short-term further dollar weakness if Draghi and European government officials get their act together."
Since Draghi's comments the krona has gained 4 percent against the dollar, followed by the Norwegian krone's 3.2 percent advance and the Swiss franc's 1.9 percent appreciation.
While expectations for a stronger dollar are declining in the futures market, investors are moving back into U.S. government bonds after a selloff last month, a sign they anticipate growth will remain subdued. The median estimate of more than 70 economists surveyed by Bloomberg is for gross domestic product to expand 2.15 percent this year.
Speculators raised bullish positions in 10-year Treasury note contracts this month to the highest since March 2008 as yields surged to 1.86 percent Aug. 21, amid the worst losses for a four-week period since December 2010.
The dollar may gain support after Germany's Bundesbank signaled opposition to Draghi's proposal to buy European bonds and contain borrowing costs. The U.S. currency snapped a four- day decline against the euro on Aug. 24 after two ECB officials said the plan may be held up until a German ruling on the legality of Europe's permanent bailout fund. The people spoke on condition of anonymity because the deliberations aren't public.
"A lot of what has happened in the past couple of weeks is just based on hope and rhetoric about the ECB, and the markets will become doubtful once again," Derek Halpenny, the European head of global markets research at Bank of Tokyo-Mitsubishi UFJ Ltd. in London, said in an Aug. 24 interview.
Halpenny sees the U.S. currency appreciating to about $1.18 per euro by February. "The story is still one of dollar strength and certainly we think QE3 is not going to have the same effect. The focus is still going to be on Europe, and there's still scope for disappointment," he said.
During the first seven months of the year the dollar rose 5.3 percent versus the euro and 1 percent against the krone, boosted by dimming prospects for the global economy. Spanish Prime Minister Mariano Rajoy said March 2 that the country would miss its budget deficit target. The nation subsequently sought as much as 100 billion euros in European rescue loans for its banks.
Working against the dollar are some of the lowest interest rates in the developed world. The Fed's target rate for overnight loans between banks has been in a range of zero to 0.25 percent since December 2008. Benchmark interst rates in Australia, New Zealand and Sweden are 3.5 percent, 2.5 percent and 1.5 percent.
At the same time, signs of strength in the U.S. economy are encouraging investors to wade into riskier assets and diminishing speculation the Fed will need to do QE3.
The Labor Department said on Aug. 3 that employment increased 163,000 in July. The median estimate of 89 economists surveyed by Bloomberg was for an increase of 100,000. A report from the Commerce Department on Aug. 14 showed that July retail sales rose 0.8 percent, the most since February.
The Citigroup Economic Surprise Index for the Group of 10 countries, which measures how much data is beating or trailing the median forecasts of analysts, climbed to a three-month high of minus 26.8 on Aug. 24, after sliding to this year's low of minus 56.2 on June 26.
The Standard & Poor's 500 Index of stocks reached a four- year high of 1,426.68 on Aug. 21.
While output in the euro zone will shrink this year, developed economies including the U.S., New Zealand and Norway will expand, according to economist estimates compiled by Bloomberg. Japan's gross domestic product is forecast to grow 2.5 percent in 2012, while Australia's will climb 3.6 percent, separate analyst predictions show.
"Better economic data, particularly from the U.S., and the hope that something will be done by the ECB has improved sentiment and removed some of the safe-haven flows from the dollar," Ken Dickson, an investment director of currencies at Edinburgh-based Standard Life Investments, which manages $257 billion, said on Aug. 21 in a telephone interview. "We've seen some of this haven demand removed from the dollar."