For Efstathopoulos, the dollar is also attractive as a diversification given the elevated correlation between bonds and equities.
Risk Premium
JPMorgan contends geopolitical tensions will support the dollar as the U.S. election takes center stage in 2024. If current polling holds, risks for the currency will be skewed to the upside given the possibility of new trade tariffs.
Any future expansion of U.S. tariffs on nations and trading blocs beyond China would have an outsized effect, strategists including Chandan wrote in a Nov. 27 note. A universal 10% tariff may boost its trade-weighted value by 4% to 6% as a widening trade war weighs on pro-cyclical, growth-sensitive currencies.
While non-commercial net positions in the dollar—a proxy for speculative positioning—retreated from a one-year high, market participants are still overall long, according to data from the Commodity Futures Trading Commission.
The consensus, though, is still for the greenback to decline more—it gained in 2021 and 2022 and is set to end this year slightly weaker—as the Fed begins cutting interest rates.
“The game changer top down would be a U.S. recession,” said Monica Defend, head of Amundi Institute, part of Europe’s largest asset manager, who expects the yen to climb to 135 per dollar by year-end. “The dollar would be vulnerable to pullbacks as the Fed moves from policy tightening to policy easing,” she said.
It’s a view echoed by Bhanu Baweja, who forecasts that the euro could rally to at least as high as $1.15 by year-end from around $1.09 now. “Interest-rate differentials contracting against the U.S. is probably going to be the primary force,” said the UBS Investment Bank strategist, who has priced in 275 basis points of Fed rate cuts next year.
A rate increase in Japan—a prospect that markets are pricing in for next year—will boost the yen as higher yields increase the appeal of Japanese assets. The yen is at around 142 per dollar.
Meanwhile, BlackRock Inc., the world’s largest asset manager, is braced for the dollar to stay range-bound from here.
“We are fairly neutral in our dollar allocation and are not positioning for a big move in either direction,” said Russ Koesterich, portfolio manager for BlackRock’s global allocation fund.
What Bloomberg Strategists Say...
"With global borrowing costs set to stay elevated for some time, it appears problematic to restrict the focus just to the expected rate of change in yields," said Bloomberg's Market Lives strategist Mary Nicola. "Differentials will need to narrow a lot more to lead to a sustained dollar pivot."
Those writing off the continued dominance of the dollar have often ended up losing out, with calls that the greenback had peaked proving premature earlier this year. It put on an unexpected run from July to October as a string of positive U.S. economic data undermined the case for monetary easing. The Bloomberg dollar gauge then tumbled almost 3% last month as Fed officials signaled they’re probably done with raising rates.
Yet the speed and magnitude of the dollar’s recent fall isn’t a guarantee for further dramatic weakening ahead, according to Goldman Sachs Group Inc. and Vanguard Asset Management Ltd, who forecast only a shallow decline. Before the Fed meeting, Goldman had forecast a 3% drop in the dollar index over the next 12 months, while Vanguard projected a decline of just over 1%.
“Next year, it’s more about what the other side of the equation—what Europe, the U.K., China and Japan—are doing,” said Richard Benson, co-chief investment officer at Millennium Global Investments, who predicted at the start of this year that the dollar would weaken.
This article was provided by Bloomberg News.