In This Article:
(Repeats Dec. 20 column, text unchanged)
By Jamie McGeever
LONDON, Dec 20 (Reuters) - When the economic storm clouds are gathering, a U.S. recession is on the horizon, stocks and long-term bond yields are falling, and the U.S. yield curve is close to inverting, you'd expect the dollar to strengthen.
Investors hunker down, U.S. capital flows back home and there's a surge in global demand for safety and liquidity. All that points to a stronger dollar, especially when the Fed is virtually the only major central bank tightening policy, meaning U.S. interest rates and yields are significantly higher than those elsewhere in the developed world.
But after the Fed raised rates on Wednesday for the ninth time this cycle to 2.25-2.50 percent, and signaled it will continue withdrawing post-crisis stimulus next year, the dollar fell. Sharply.
The U.S. currency had one of its worst days of the year on Thursday and is on course for its biggest weekly fall since the week immediately following the bout of "Volmageddon" stock market instability in February.
So what gives? There's no obvious reason, but there are a few plausible explanations.
The first is market positioning. Investors and traders collectively hold a huge long dollar position, so there's a natural bias towards lightening that load as the year-end draws closer.
Bank of America Merrill Lynch's latest monthly poll released this week showed that the "long dollar" trade is the most crowded trade in the world among the fund managers surveyed.
Hedge funds and other speculators trading U.S. futures markets have been net long of dollar since June, and earlier this month increased it to more than $31 billion, the highest in nearly two years.
They began scaling it back last week, but at $28.5 billion it is still substantial, and there's certainly more room to unwind in the coming weeks and months.
That dovetails with the broader consensus view in currency markets that the dollar next year will give back some of its gains from this year. The latest Reuters poll of more than 60 currency analysts, taken Nov. 28-Dec. 5, points to the dollar weakening by around 5 pct next year.
So perhaps, as 2018 ends and investors set out their stall for 2019, the dollar is reacting accordingly.
Of course, exchange rates are relative, so U.S. monetary policy is only one half of the dollar's equation. All else being equal, if the Fed goes slower on rates than it had signaled, the dollar will hold its ground only if other central banks shift their stances by a similar magnitude.
But euro zone, UK and Japanese policy is already so loose - interest rates in the euro zone and Japan are negative - that there is limited room for these central banks to ease. On the margins, a more dovish Fed and neutral ECB, BOJ and BoE is a drag on the dollar.