U.S. money managers are reversing a decade-long trend of diversifying away from the dollar, leading more strategists to conclude that a rally that's taken the currency to a four-year high is just getting started.
Investors based in the U.S. hold 19.3 percent of their $35.8 trillion of equities in foreign shares, down from a peak of 21.1 percent in 2009, according to new Federal Reserve data tracked through June by UBS AG. After surging from 8.3 percent in 2003, the proportion of their $11.4 billion of bonds, excluding Treasuries, that is in foreign debt has stabilized at 20.9 percent.
“This, and the fact that relative growth is better in the U.S. and the currency is still cheap, means the dollar will rise further,” Geoffrey Yu, a senior currency strategist at UBS in London, said by phone on Oct. 16.
America's currency has been supported for much of this year by the prospect of higher U.S. interest rates and a divergence in monetary policy between the Fed and its counterparts in Europe and Japan. More recently, it's been in demand as a haven from signs of a slowdown in the world economy, the spread of Ebola, the conflict in Ukraine and street protests in Hong Kong.
The greenback has strengthened versus all 16 of its major peers this year, with the rally gathering pace since June. The Bloomberg Dollar Spot Index rose to 1,080.05 on Oct. 3 from 1,019.14 at the end of last year. It was at 1,063.50 at 9:58 a.m. in London.
The dollar climbed to a more than two-year high of $1.2501 per euro this month amid growing evidence of weakness in Europe's economy. It was little changed at $1.2756 today. Median forecasts in Bloomberg surveys predict the dollar will advance against most major currencies by the end of 2015.
“This is very much a move out of euros into dollars,” Ian Stannard, the head of European foreign-exchange strategy at Morgan Stanley in London, said by phone on Oct. 16. “The broader portfolio flow taking place over time was one of the driving forces that took the euro higher and dollar lower, and now the trend is starting to shift.”
Similar to U.S. investors, central-bank reserve managers are getting back into dollars. Together, these two groups are the largest holders of the U.S. currency, so the shift is a potential turning point that may see it appreciate faster than at any time since the 1990s, according to UBS.
Foreign Reserves
As of June, the dollar accounted for 60.7 percent of the $6.3 trillion of reserves for which central banks report currency breakdowns to the International Monetary Fund. That's up from an all-time low of 60.3 percent in March and 60.5 percent three years ago.
The greenback's share peaked at 72.7 percent in 2001 and then fell in seven of the last eight years. The euro's portion of reserves declined to 24.2 percent in June, versus 28 percent in 2009.
“This is the first time reserve managers are aligned with the private sector,” Stephen Jen, managing partner at SLJ Macro Partners LLP and a former IMF economist, said by phone from London on Oct. 16. “In 2002 and before, the central banks were not in synch with the private sector. The dollar's in good shape.”
Signs of slack in the U.S. economy, including a report last week showing a drop in retail sales, have pushed back traders' expectations of when the Fed will raise interest rates from the zero to 0.25 percent range they've been in since 2008. Futures prices compiled by Bloomberg suggest an increase in December 2015, from the September boost seen as likely two months ago.
“All of the drivers for the dollar are sort of dwindling,” Stephen Duneier, the founding partner of Santa Barbara-based Bija Capital Management LLC, said in an Oct. 16 phone interview. “In Europe, now, everyone is struggling. Japan, China and Brazil are also all struggling. But people seem to think that, somehow, the U.S. is able to work its way out and it has some magic potion.”
Economists surveyed by Bloomberg see U.S. growth exceeding that of the Group of 10 developed nations in 2015. Plus, the Fed is still withdrawing its stimulus, just as the European Central Bank and Bank of Japan talk about extending currency depreciating policies.
BNP Paribas SA sees the dollar appreciating 11 percent to $1.15 per euro by the end of next year, according to a forecast submitted to Bloomberg on Sept. 23. The median estimate in the survey is for a 6 percent gain to $1.20.
“The Fed next year will be in tightening mode and the ECB will deliver more measures,” Daniel Katzive, a strategist at the French bank in New York, said by phone Oct. 16. “So the policy divergence theme that's the crux of our forecast profile will be very much with us.”
Bloomberg News
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