Dollar in Cross-Hairs as Trade Truce Fails to Derail Fed Bets

(Bloomberg) -- The U.S.-China trade truce hasn't been enough to shake out one favorite trade: shorting the dollar.

The easing of tensions has done little to shift the market's expectations for Federal Reserve interest-rate cuts, which means markets will keep selling the greenback, according to Aberdeen Standard Investments. Should the U.S. and China eventually reach a full-fledged trade deal, the greenback will lose appeal as a haven, AMP Capital Investors Ltd. says.

The dollar has weakened about 2% from this year's high in May after the Fed signaled it was open to lowering borrowing costs for the first time in more than a decade. Funds have cut long positions on the world's reserve currency for three straight weeks, with swap markets indicating a rate cut in July will kick off an easing cycle.

“The U.S. dollar has peaked, and once a deal is eventually announced and the Fed cuts interest rates, we'll see it trend even lower,” said Shane Oliver, head of investment strategy at AMP Capital in Sydney. “It won't fall in a straight line, but it will fall.”

Emerging markets will be the biggest beneficiaries, Oliver said.

Aberdeen Standard Investments is shorting the greenback against the Aussie and some Asian currencies, said David Choi, head of Australian macro - fixed income in Sydney.

“Without a material geopolitical shock in markets, which the G-20 meeting averted to some degree, we think there is room for the U.S. dollar to depreciate against the cyclical currencies like the Australia and New Zealand dollars,'' Choi said. “We do see dollar weakness as one of the key themes in markets going forward.”

Fed Pricing

Before the G-20 meeting, futures traders had priced in about a percentage point of Fed cuts in the coming year. While they trimmed bets a little Monday, the market still expects a quarter-point move this month and further easing after that.

Treasury 10-year yields climbed Monday as part of a market-wide risk-on move, but they're still close to 2%. Citigroup Inc. even recommends that investors position for a further drop in yields amid global central-bank dovishness.

“Even in the most hawkish Fed scenario a rate cut is coming in 2019,” wrote Citigroup strategists led by Jabaz Mathai. A long position in Treasuries will “benefit from any easing-induced reach for yield.”

Been Here

The greenback advanced against major peers Monday following the rise in yields. Some dollar holders were unswayed by the weekend developments.

Salter Brothers Asset Management Pty has been buying the dollar against the Aussie for the past 18 months and says it will keep doing so until it sees a definitive end to the trade war.

“We've been at a trade truce before,” said George Boubouras, Melbourne-based director at the money manager. “Until there's more signs of global growth momentum, of a timeline to a trade deal, we're happy to maintain the long dollar trade.”

The Intercontinental Exchange Dollar Index climbed toward its 200-day moving average before giving up some of that move. A failure to rise above that level could embolden U.S. currency bears.

Global economic weakness was again highlighted Monday, with euro-area and U.K manufacturing figures dropping more than expected. Those followed disappointing data from Japan and China. The European Central Bank will cut rates by 20 basis points and restart quantitative easing in September, according to Goldman Sachs.

With few details released so far about the U.S.-China trade truce, traders will look to this Friday's U.S. payrolls report for indications on the strength of the world's biggest economy and the prospect for policy easing.

There's scope for the dollar to weaken this week as attention turns from trade to the prospects of a July Fed cut, Joseph Capurso, senior currency strategist at Commonwealth Bank of Australia, wrote in a note. “We believe a 25 basis point cut to the Fed funds rate on 31 July is a virtual certainty,” he said.

QIC Ltd., which manages the equivalent of $60 billion, has ratcheted up short positions in the dollar against the euro and the yen.

“Six-to-12 months ago, there was a clear period of exceptionalism in the U.S.,” said Stuart Simmons, senior portfolio manager at QIC in Brisbane. “They had exceptional Fed policy compared to other central banks, corporate earnings, equity market performance. Now you're at an inflection point where that exceptionalism is being challenged in almost all areas.”

--With assistance from John Ainger and Benjamin Purvis.

To contact the reporter on this story: Ruth Carson in Singapore at rliew6@bloomberg.net

To contact the editors responsible for this story: Tan Hwee Ann at hatan@bloomberg.net, Nicholas Reynolds

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