Hedge funds have significantly scaled back their optimism on the dollar, slashing net long positions against major and emerging currencies by $5.5 billion, the largest weekly swing since July and the second-largest this year. The move appears to be a response to the rising expectations of U.S. rate cuts in the coming year, potentially undermining a crucial support factor for the currency in the months ahead.
The latest data from the Commodity Futures Trading Commission (CFTC) reveals that in the week ending Nov. 14, funds reduced their net long dollar position to $4.5 billion from $10 billion the previous week. This comes as the interest rate futures market has begun pricing in up to 100 basis points of Federal Reserve rate cuts by the end of the next year.
While recent market sentiment has somewhat tempered the dovish outlook, traders, anticipating significant easing in the second half of next year, are closely watching Federal Reserve actions. Whether this pullback in dollar optimism is a temporary pause or a more enduring shift depends on future Fed decisions.
JP Morgan’s currency strategy team highlighted in their 2024 outlook, “Large USD weakness requires Fed cuts and better ex-US growth, but these conditions are not met yet.”
In the week ending Nov. 7, funds held a $10 billion net long dollar position, marking the most substantial bullish bet on the greenback since October last year. This stark contrast followed a net short position exceeding $20 billion in mid-July, indicating a momentum suggesting the formation of a base for a prolonged dollar upswing. However, the dollar has experienced a 3% slide in November, marking its worst month in a year.
Potential Shift in Trends:
Contrary to historical trends where CFTC funds’ net dollar positions were long-term, directional trades held for at least a year, the current scenario may be different, with funds only maintaining net long positions for nine weeks.
The recent liquidation of long dollar positions in the week ending Nov. 14 primarily targeted the euro and Japanese yen. Hedge funds increased their net long euro position by $2.9 billion, the most significant surge since July, reaching almost $18 billion, the highest in three months. Simultaneously, they reduced their net short yen position by $2 billion, nearly reversing the previous week’s move that had positioned the overall net short yen position as the largest in six years.
Despite the stretched positioning, if the Bank of Japan signals an early end to negative interest rates, the yen’s potential upside is substantial. The currency currently lingers near a 33-year low against the dollar, a 15-year low against the euro, and a 50-year low on a real effective exchange rate basis.
Morgan Stanley’s FX strategy team noted in their 2024 outlook, “The clear exception to widespread USD strength is JPY, which ends up the broad-based outperformer: We see USD/JPY falling to 142 by mid-2024.”