There have only been six similar cases in the past 20 years where fund managers have rapidly reduced their holdings in the US dollar. Recently, the US dollar index has rapidly depreciated by about 10%.
Investors are selling off the dollar at the fastest rate in a year as the market expects the Fed to end interest rate hikes and cut interest rates several times next year.
State Street Bank (State Street), which has managed assets of $40 trillion, said that asset management companies are expected to sell 1.6% of their open positions in US dollars this month, which is the biggest monthly capital outflow since November last year. The bank said that since the US released weaker-than-expected employment data on November 3, fund managers have carried out “major” sell-offs every day.
To some extent, this contributed to the worst monthly performance of the US dollar in a year. Analysts have warned that the sell-off of asset managers may only be the beginning of a long-term trend for investors to reduce their exposure to US assets.
Michael Metcalfe (Michael Metcalfe), head of macro strategy at State Street Bank, said, “The flow of capital over the past two weeks shows that investors are reconsidering their demand for the US dollar,” adding that the recent sell-off marks the end of “unusually congested dollar long positions.” He said, “Investors think 'if the Fed actually cuts interest rates, then I don't need to hold that many dollars'.”
According to State Street Bank, there have only been six similar cases in the past 20 years where fund managers have rapidly reduced their holdings in dollars. The most recent one occurred in November last year, and since then the US dollar index (which measures how much the US dollar's exchange rate has changed against a basket of currencies) has depreciated by about 10% by the end of January.
Metcalfe added that despite the recent sell-off of the US dollar, asset managers have increased their holdings of the US dollar compared to other currencies, which indicates that there may be room for the dollar to decline further.
The US dollar rose sharply last year, driven by the Fed's interest rate hike. By the end of September, the US dollar index had risen by as much as 19%, bringing huge profits to macro hedge funds with bullish positions, but it weakened sharply in the fourth quarter of last year.
Between July and October of this year, the US dollar once again rose sharply by more than 7% as strong economic data pushed the US benchmark borrowing cost to the highest point in 16 years and convinced investors that interest rates would remain high for longer.
But in recent weeks, things have changed again. The US CPI inflation rate fell to 3.2% in October, a decline that exceeded expectations, which prompted investors to almost completely rule out the possibility of further interest rate hikes. The US dollar index has fallen back to roughly the same level as at the beginning of the year, and the interest rate futures market now expects the Fed to cut interest rates by more than 0.5 percentage points by September next year.
Geoff Yu, a foreign exchange strategist at Bank of New York Mellon (BNY Mellon), which has a custody scale of 46 trillion US dollars, said that in the past 20 days, the company's clients have “sold the US dollar at the fastest rate since this year,” and are more inclined to buy yen, Canadian dollars, and a range of Latin American currencies.
The weakening of the US dollar is good news for Japan's Ministry of Finance. Earlier this month, the exchange rate of the yen against the US dollar was close to a 33-year low. This has increased inflationary pressure in Japan, pushed up the cost of imported goods, and made the Ministry of Finance have to prepare for monetary intervention.
Although the yen depreciated about 12% against the US dollar this year, the pair appreciated by about 1.5% in November, providing some respite for the yen's decline.
Yu expects the yen to continue to strengthen, and the Bank of Japan expects the Bank of Japan to abandon its negative interest rate policy within the next few months. He said, “Shorting the yen doesn't make much sense because every policy meeting of the Bank of Japan will be a real-time event.”
The weakening dollar has also brought some relief to emerging market countries. This makes it easier for them to repay their dollar-denominated loans and may begin to attract investors back to emerging markets after a massive sell-off of hard currency debt this year.
“We have increased our holdings of emerging market stocks and commodities.” Florian Ielpo (Florian Ielpo), head of macro multi-asset at Lombard Odier Investment Management, said that the weakening US dollar environment is “breaking some popular reasons for bullish US stock markets.”
The MSCI Emerging Markets Stock Index has risen 3% so far this year, far behind the S&P 500 index's nearly 19% increase.
Francesco Sandrini (Francesco Sandrini), head of multi-asset strategy at Amundi, said that entering 2024, he expects the dollar to continue to weaken, “partly because we expect the turmoil between the two major countries to decrease,” which means that investors' demand for the US dollar as a safe haven will decrease.
However, he added that since the Russia-Ukraine conflict began, the usual rotation between developed markets and emerging markets “had some problems”. He pointed out that investors prefer the Mexican and Brazilian stock markets, in part because they think these countries are in a favorable political position.
He said, “We have seen that many people are interested in emerging markets, but I think the weakening dollar and geopolitical concerns are a bit of a conflict between these two forces.”
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