Investors see more tactical dollar trades in 2022

Investors see more tactical dollar trades in 2022

The dollar is poised to climb next year, according to investors. Even before the end of 2021, the juiciest trades may be over.

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Everyone from Morgan Stanley to Sumitomo Mitsui Trust Asset Management to Lombard Odier predict a stronger greenback in 2022 - with the caveat that its advance will be tempered. The situation is because traders have been front-running a hawkish Federal Reserve, opting to buy the world's reserve currency against virtually all of its peers before borrowing costs rise.

The dollar is expected to improve in the first half of 2022, as the Fed likely ends tapering in March and starts raising rates in June, said Naoya Oshikubo, chief manager at Sumitomo, which oversees about $740 billion in assets. The dollar may surrender some of its gains in the second half, but its adjustments will be moderate in order to remove the excess rally related to the heightening expectations prior to rate hikes. According to a Bank of America Corp. survey, the Bloomberg Dollar Spot Index is poised for its best annual gain in six months this year, and fund positioning has turned bullish since 2015, despite the fact that it has gone up around 5% this year. The long bets on the currency have climbed to the highest since June 2019 as anticipation builds around the impact of tighter U.S. monetary policy.

It was a dramatic reversal from this time last year when shorting the dollar was one of Wall Street's most crowded trades.

That hypothesis of a larger U.S. deficit and a broad global recovery favoring assets outside America and weakening the dollar didn't pan out. The Fed monetary stimulator helped fuel a rally on Wall Street that brought in more money from around the world while most emerging markets sluggished.

Some traders are suggesting the dollar gains may fall in 2022, or that the currency may even drop as traders gear up for rate hikes.

In the six months preceding the first U.S. interest rate hike, the dollar has traded with strength, said Arjun Vij, portfolio manager at JPMorgan Asset Management, who believes that the greenback is gaining against the euro, Swiss franc and yen. The bond market may try to price a policy mistake in the U.S. Eurodollar futures pricing, which suggests traders expect three Fed rate hikes next year, with two to three rate increases already baked into markets.

Inflation risk is on Morgan Stanley's radar, even as the firm recommends long dollar positions against lower-yielding currencies, including the euro.

David Adams, head of G- 10 FX strategy in New York, said that if inflation decelerate next year, some members of the Fed committee could argue for patience in raising rates.

That policy divergence narrative is moving to a policy convergence narrative - where maybe the Fed is dovish than people expected, but other major central banks are starting to move toward the exit, which would be the most negative for the dollar, he said.

Money manager Malcolm Dorson thinks there is an opportunity for the dollar to reverse in 2022, as the U.S. fiscal stimulus rolls off and the vaccination rates taper while the rest of the world picks up.

As global vaccine rates improve and the world begins to live with Covid 19 as an endemic, the flight-to-quality trade should unwind, providing more tailwinds for international currencies, Dorson said.

Eric Stein, chief investment officer at Eaton Vance, believes that a short omicron wave, followed by a global recovery that brings a measure of dollar weakness, is a possibility.

The data from Bloomberg shows tactical dollar trades in 2022, with strategists expecting the ICE U.S. Dollar Index to climb just a tad over 1% by the fourth quarter.

It is about modest dollar strength and more nuanced views, said Homin Lee, a macro strategist at Lombard Odier in Hong Kong. The firm, which currently holds long dollar positions across some portfolios, sees the euro falling to 1.10 per dollar and the onshore yuan falling to 6.45 level by the third quarter.

John Vail, the firm's chief global strategist in Tokyo said that the main driver of the dollar is higher interest rates, but the issue is that a lot of it is already baked into markets. There is a dollar strength ahead, but don't expect it to be spectacular. Customers have already caught on to the Covid Excuses, and none stop with the Covid Excuses.

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