Is the return of dollar longs the trade for the rest of the year?
- The US dollar gains accross the FX dashboard on renewed strength
- ECB hints at a 50bp rate hike in December instead of 75bp
- End of the year positioning might bring renewed dollar strength
The trading week started with the US dollar gaining ground across the FX dashboard. EUR/USD dropped more than -0.8%, AUD/USD as well, and USD/JPY traded above 141 again.
The return or Dollar long trades is somewhat surprising, especially because long trades have been cut to zero in recent weeks. Out of all the currencies, the dollar suffered the most against the euro, as markets were going long the euro, as reflected in the EUR/USD exchange rate trading above 1.04 last week.
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But the euro’s strength might be tricky.
Speculative positioning in the FX market has gone all out long euro, even though the toughest winter months are still ahead. Also, it appears that most traders believe that we have seen the low in the EUR/USD exchange rate, hence the extreme positioning on long euros.
Because of that, the correct positioning for the end of the trading year is difficult.
ECB hints at a 50bp rate hike in December
One of the reasons why the EUR/USD exchange rate moved today is an interview with the European Central Bank’s Chief Economist, Philip Lane. He hints at a 50bp rate hike as the likely outcome at the December meeting, as a 75bp hike is no longer viable.
The interest rate differential was seen as narrowing after the latest inflation report in the United States. But if the ECB backs down from its 75bp rate hike, as hinted by Lane today, then the EUR/USD exchange rate has more room to the downside.
What if the US inflation surprises to the upside?
Markets rallied, and the dollar weakened after the October inflation report revealed that the rise in the prices of goods and services might have peaked in the United States. However, more progress is needed and the danger is that the November inflation report will disappoint. If that is the case, traders will likely increase their dollar long positions towards the end of the year.
Renewed dollar strength might be possible
This week is a short one because of the Thanksgiving holidays. Going into December, most investment houses will focus on reducing risk ahead of the end of the year flows and rebalancing their portfolios.
If the recent dollar weakness is viewed as just a bounce in a bull market, then renewed dollar strength might be possible in the few trading weeks left.