US dollar has been the market’s whipping boy for some time now. For the last three months, the world’s reserve currency has persistently fallen against other currencies and most commodities, in a pattern described by one analyst as “everything up/dollar down”. With yields on dollar-denominated assets lower than ever before, lots of traders are holding very short positions, betting that the carry trade, where investors borrow from the US and then invest in higher yielding assets, will continue.
Some are beginning to question whether that it can, however. The G20 meeting last weekend initially prompted further selling of dollar assets as traders decided that nothing really had changed. That has, however, now tailed off and the dollar is now looking rather flat, and which way it will go is questionable. According to Adrian Schmidt, an analyst at Lloyds TSB, the markets are “leaning towards a weaker dollar” but ultimately, they are waiting out events.
At the top of the events calendar is the meeting of the Federal Reserve committee meeting next Wednesday, followed by the unemployment data due to be released on 5 November and then by the G20 meeting on 10 November. According to Schmidt, the biggest fear is that any one of those events will deeply unsettle markets, leading traders to suddenly unwind risky carry trades and push the dollar sharply back up again.
That seems relatively unlikely, however. A bigger question is whether the markets have accurately priced in the effects of quantitative easing. Michael Hewson, of CMC Markets, says that, if anything, markets have probably been too aggressive in selling the dollar. When a second round of quantitative easing was first suggested, the euro was at $1.26 – it is now at $1.40. This week the yen hit a 15-year high against the dollar. So far, traders have treated the greenback as a particularly bad bet. With a little bit more certainty about monetary policy, many may reverse course.
There were some signs yesterday that that was already starting to happen, with the dollar nudging up and everything else nudging back down again. Effectively, the dollar has been acting like a fat kid on a seesaw – as it has fallen, it has pushed everything else up. The other end of the seesaw has now got quite heavy, and equities and other currencies may be due for a correction.
It would hardly be that surprising. For three months, traders have been very bearish on the dollar. They have stacked up the short positions like pancakes at breakfast. Now they are just waiting for the signal to eat, and it is due to come next week.