(Bloomberg) - Buy the dollar, sell almost every other currency may be the mantra for investors heading into the new year.
The greenback is set for its biggest annual gain in six years and its rally appears to be far from over, market participants say. The prime mover: a hawkish Federal Reserve that’s drawn a roadmap of interest-rate increases over the next three years, while other central banks look much more reticent to withdraw stimulus.
“Broad-brushed dollar strength -- that’s what you should prepare for,” said Vishnu Varathan, head of economics and strategy at Mizuho Bank Ltd. in Singapore. “Commodity currencies could be sold off harder, and emerging markets will also come under pressure even if their central banks raise rates. It won’t be enough to offset what the Fed’s likely to do.”
Investors’ positioning in the dollar and views toward the currency have turned the most bullish since 2015, according to a Bank of America Corp. survey published this month. The greenback has strengthened versus all of its Group-of-10 peers in 2021, with the Bloomberg Dollar Spot Index advancing 5.7% over the period to trade near the highest since July 2020.
There’s a precedent for multi-year gains too, with the dollar gauge rising for four straight years through 2016 for a combined 28% advance.
Major Slumps
While Bloomberg’s dollar index closed down 0.2% on Wednesday after the Fed decision was broadly in line with market consensus, investors say any such declines are likely to be short-lived.
Sumitomo Mitsui DS Asset Management Co. favors the greenback against the yen, saying the dollar will outperform as the Bank of Japan struggles to normalize monetary policy amid weak inflation.
“I see the Fed starting to shrink its balance sheet in 2023, which is supportive of the dollar,” said Kei Yamazaki, a senior fund manager at Sumitomo Mitsui DS Asset in Tokyo. “Fed policy normalization is justified by U.S. economic growth that’s outpacing others. I expect the dollar to strengthen further given the Fed’s policy path forward.”
While markets are already factoring in multiple rate hikes from the Fed, there’s still room for additional hawkishness to be priced in, according to National Australia Bank Ltd. In contrast, the euro and pound are set to be dragged down by rising energy prices and a dovish European Central Bank, the bank says.
“The 2022 risk is that we get four instead of three hikes” from the Fed, which will boost dollar strength, said Rodrigo Catril, senior currency strategist at NAB in Sydney. “We see the risk of euro trading sub $1.10, and the pound below $1.30.”
More Vulnerable
Fund managers are betting the dollar will remain in an uptrend against most emerging currencies too, arguing that rising U.S. yields are likely to weigh on current-account deficits in many developing nations.
MSCI’s emerging currency index has whipsawed this year and is currently little changed over the period, with strength in the Israeli shekel and Chinese yuan being offset by slumps in the Turkish lira and Argentine peso.
Read More: Wave of Rate Hikes No Cure to Emerging-Market FX Weakness
While an all-out dollar buying spree is not Scotiabank’s base scenario, strategist Qi Gao in Singapore sees India, Korea and Thailand’s currencies to be among the most vulnerable. “For the rupee, it is facing capital outflows and bouncing oil prices,” he said.
By Ruth Carson and Masaki Kondo
