Tommy Wilkes and Saikat Chatterjee

LONDON, (Reuters) – The rally of the dollar to its two-decade-highs seems to be stalling. There are growing doubts about whether the U.S. will remain as resilient as expected and if monetary policy will continue to be as aggressive as it was previously anticipated.

The greenback fell 3% in May 13 after climbing 10% over three months. Many believe that the Russia-Ukraine conflict has slowed the safe-haven bid. Others believe the Federal Reserve would be able to push the U.S. into recession by significantly tightening its monetary policy.

Final note: While U.S. rate increases will continue to outpace other major economies’, there is evidence that the rate-hike slow-movers in Europe and Switzerland may be preparing for their own campaign of tightening.

Christine Lagarde, President of the European Central Bank, blasted the dollar Monday. She said that after 8 years of negative interest rates, the bloc would finally end its eight-year-long experience.

This changed the belief that many held about the impact of the war on the ECB’s ability raise rates in a significant way. The euro rose 1% against the greenback.

Richard Benson (co-Chief Investment Officer, Millennium Global), said that the European interest rates story has been steadily building and has been ignored by the market. He has moved from a strategic long dollar position to one which is “tactically shorter” earlier in the month.

The U.S.’s resilient economy and favorable geo-politics have provided the ideal environment for dollar outperformance. But, these conditions are now giving way to what Benson called a “mushy”, where economic risks are increasing.

U.S. interest rate rises are still being reflected in money markets, which have risen by about 175 basis point by the year’s close. However, they also now forecast 100 bps of ECB rises as opposed to 20 bps after Russia’s invasion of Ukraine.

BNP Paribas analysts (OTC:), stated that the Fed’s rate cycle is “now reasonably priced” and had raised “short” dollars positions relative to the Australian and New Zealand currencies.

They expect “the dollar will decline as investors resume carrying trades” unless the U.S. market experiences a surge in rate pricing.

JPMorgan (NYSE 🙂 is still positive on the dollar but said the currency markets had been reacting to an evolution from U.S.Exceptionalism to a global slowdown that encompasses all of the United States.

Recent U.S. data on unemployment, housing, and business conditions all point to a slowing of momentum.

Graphic: King dollar – https://fingfx.thomsonreuters.com/gfx/mkt/byprjdqgape/King%20dollar.JPG 278d32a1-f01f-4c8c-91fa-ba843bb7f77f1

BENIGN CASE

According to conventional wisdom, the dollar tends to strengthen in the period leading up Fed rate increases. Then it loses steam. According to Reuters analysis, Refinitiv data, in three of four recent hiking cycles, the greenback Index fell by an average of 1.4% between the initial and the final rate rise.

Many believe it still holds. Scott Bessent who manages Key Square Group said that the dollar was in its last run. In an investor letter obtained from Reuters, he stated, “When this denouement ends, we expect a multiyear weakening” of the currency. Key Square Group declined to comment.

On May 13, the dollar reached its highest level, with bullish speculative long positions exceeding $20 billion. Since then, the dollar bulls have been feeling the heat due to a nearly 20-bps drop in Treasury yields.

According to ING analysts, the Fed should halt raising interest rates from 2% in July due to the “benign case”.

Some believe the Fed may be at high risk of raising its rates too often, despite supply-side pressures which need to be addressed driving inflation.

Stuart Cole (chief macro strategist for Equiti Capital) stated, “Three too tightening by the Fed risks choking away potential investment. This could help to ease it.”

Graphic: Fx market positions – https://fingfx.thomsonreuters.com/gfx/mkt/dwpkrnzgevm/Fx%20market%20positions.JPG f74c61f9-9338-4abe-ab19-895dfea1d1212

Even with recent falls, it is still up 6.3% in 2022. It could rapidly resume its climb if there’s a European recession or global investor confidence.

Benson, Millennium sees the U.S. Currency’s ongoing decline continuing. However Benson believes the most recent peak of the dollar was a high and that it is “a very important call to make.”