With the US Federal Reserve expected to raise rates for the first time since 2004 next month, should every man and his dog be long dollar? Or is this a good example of a “buy the rumour, sell the news” rally?
Looking at the statistics of the eight Fed rate hike cycles since 1971, we should be booking profits on long dollar positions by the first rate hike in December, and should maybe even short the buck if technical analysis allows for it. For now, though, I am a dollar bull as it’s not the case that every man and his dog is undeniably long the dollar. In fact, according to the FXCM SSI index, the average retail trader is positioned against the dollar. Fighting the decline in the euro-dollar, sterling-dollar, and the rally in dollar-Canadian dollar, in the case of the dollar-yen, they are long.
DOLLAR LOSSES ON RATE HIKES
In five out of the eight interest rate hike cycles since 1971, the US dollar fell from the start of the first rate hike to the last – that is 62.5 per cent of the time. And the declines were not small by any means: the average decline of the US Dollar index is usually 11 per cent by the end of the rate hike cycle. One possible explanation could be that rate hike cycles tend to be followed by recessions and, as a consequence, the higher short-term interest rates do not tend to be sustained. Rather the rate is lowered on the onset of a recession.
Another rather bleak statistic for dollar bulls is that, although the dollar gained three times out of the eight – in 1980, 1983 and 1999 – it fell by roughly 4.5 per cent in the first few months of the 1999 cycle before trading higher.
This means that 75 per cent of the time, the dollar tends to soften in the first few months after the first rate hike. With these stats, we should be attentive to any major reversals at the Federal Open Market Committee meeting on 16 December.
For now, however, I remain bullish as the market is only pricing in two and a half rate hikes in the next 12 months, while the Fed expects to hike five times. Also important is that not everyone is long the dollar. In fact, a large portion of traders are betting on the dollar to soften.