FX: the US dollar "no longer"? yen, emerging market currencies may be boosted

Since the start of the year, the dollar has not performed as the market predicted for a prolonged slump. The dollar's resilience has baffled bears, who have warned that it will weaken for years to come after a surge in 2022. Now, a growing number of investors believe that these bears may finally prove correct, as easing inflation provides support for the Federal Reserve to end its rate hike cycle in the coming months.

　　Some top fund managers say the dollar is weakening as US interest rates are approaching their peak and the Federal Reserve's aggressive tightening policy is starting to take its toll on the US economy.AllianceBernstein and UBS Asset Management said it would cost the yen,New Zealand dollar(0.6350, 0.0060, 0.95%), andBrazilian realandColombian pesoThe strengthening of emerging market currencies creates conditions.

　　Brad Gibson, co-head of Asia Pacific fixed income at AllianceBernstein, said: "Overall, we would probably think the dollar has peaked and other currencies could have better room to perform in the second half of 2023-2024." He said that was because the US economy would slow and the Federal Reserve could start easing monetary policy.

　　The market reaction to Wednesday's US inflation data for June appeared to justify a bearish trend towards the dollar. The Bloomberg dollar spot index fell to a 15-month low and is now down more than 11 per cent from its September peak. Hedge funds are net sellers of the dollar for the first time since March, according to data from the Commodity Futures Trading Commission.

　　Against this backdrop, investors are betting on currencies that will benefit from a weaker dollar. The yen is seen as the main beneficiary, with yen bulls seeing catalysts such as fears of a US recession, a narrowing of the US-Japan interest rate differential and the Bank of Japan's likely adjustment of its ultra-loose monetary policy in the coming months.

　　Jim Leaviss, chief investment officer of the public fixed income arm of M & G Investments with $366 billion in assets under management, is shortingUSD/JPY(138.32, -0.1000, -0.07%)Exchange rates. "There are a lot of opportunities in the currency market right now. A lot of emerging market currencies look cheap," he added.

　　1. A weaker dollar will benefit currencies such as the yen

　　All G10 currencies have strengthened against the dollar in the past month. The yen has gained 4% against the dollar in the past five sessions, and the Swiss franc has risen to its highest level against the dollar since 2015.Euro(1.1157, 0.0029, 0.26%)、Pound Sterling(1.3034, 0.0046, 0.35%)Against the dollarExchange rates have reached new highs in more than a year. Emerging market currencies have also improved. The MSCI index of emerging market currency assets is up 2 per cent this year after falling 4 per cent last year.

　　Shamaila Khan, head of emerging markets and Asia Pacific fixed income at UBS Asset Management, thinks Latin America's currencies, including Brazil, Mexico, Chile and Colombia, could outperform, noting that they have all risen against the dollar this year, with the Colombian peso up 18 per cent against the greenback.

　　"We like the currencies of these countries because their double-digit spreads against the dollar provide high yields," said Mr. Khan. "We expect the dollar to weaken in the second half."

　　Christian Abuide, head of asset allocation at Lombard Odier, agrees that the Brazilian real, Swiss franc, euro and yen will strengthen. "We are bullish on the high spread yield offered by emerging market currencies such as the Brazilian real, supported by an environment of lower inflation and improved fiscal and external balances," he says.

　　Audrey Childe-Freeman, chief FX strategist at the G10, said: "If you continue to believe, as we do, that US interest rates will peak soon (although the Fed will not cut rates in 2023), against a backdrop of slowing US growth rather than a hard landing and rising market risks, it makes sense to bet on a weaker dollar in the second half."

　　2. Investors are still betting on a stronger dollar

　　Some investors are less sure the dollar will weaken further. Brendan Murphy, a fund manager at Insight Investment, said: "We are not taking too much risk on foreign exchange. Real interest rates in the US are still high and rising. Add to that growth concerns around the world and the US economy is doing relatively well."

　　There is some support for a stronger dollar. If inflation does not return to the Fed's target range, the Fed is likely to keep interest rates high for a longer period of time. The dollar will also strengthen, supported by risk aversion and rising recession fears.

　　Overall, however, there appears to be a growing belief that the dollar's best days are over. Rajeev De Mello, a fund manager and veteran market player at GAMA Asset Management, said the peak in US interest rates had "taken a support out of the dollar". He said he was buying the Indian rupee andMexican peso"The first phase of buying currencies other than the dollar has begun."