Dollar Strengthens as Hedge Funds Turn Bullish Ahead of Fed Meeting

The US dollar has gained momentum in the past week as hedge funds and other major investors have switched to a bullish stance on the greenback, anticipating a hawkish tone from the Federal Reserve at its policy meeting this week.

Hedge Funds Flip to Net Long on Dollar

According to data from the Commodity Futures Trading Commission (CFTC), leveraged funds and other major players held a combined 18,000 net long positions on the dollar across eight major peers in the week ended Sept. 12, versus 25,175 net shorts the week before. This is the first time since March that hedge funds have turned net buyers of the dollar, signaling a shift in sentiment toward the world’s reserve currency.

Dollar Strengthens as Hedge Funds Turn Bullish Ahead of Fed Meeting
Dollar Strengthens as Hedge Funds Turn Bullish Ahead of Fed Meeting

The change in positioning was driven by the biggest slide in euro longs since January as traders bet the European Central Bank (ECB) is about done raising interest rates. The euro fell to a six-week low against the dollar on Friday after the ECB signaled it would slow down its bond-buying program but refrained from giving any clear guidance on when it would end.

Fed Expected to Signal Tapering Plans

The dollar rally is also supported by expectations that the Fed will maintain a hawkish bias when it meets on Wednesday, despite the recent slowdown in US job growth and inflation. Investors are looking for clues on when the Fed will start tapering its $120 billion monthly asset purchases, which have been a key driver of liquidity and risk appetite in global markets.

“We expect a hawkish hold from the Fed this week that leaves the door open for further tightening,” Win Thin, global head of currency strategy at Brown Brothers Harriman & Co. in New York, wrote in a client note. “We believe the dollar rally will continue.”

Some analysts expect the Fed to announce its tapering plans as soon as November, while others think it will wait until December or early next year. The timing and pace of tapering will have a significant impact on the dollar’s direction, as well as on bond yields and equity markets.

Dollar Index Nears Key Resistance Level

The dollar index, which measures the greenback against a basket of six major currencies, rose to 93.37 on Friday, its highest level since Aug. 23. The index is approaching a key resistance level at 93.50, which has capped its gains since June. A break above this level could open the door for further upside toward 94.00 or higher.

The dollar index has gained about 3.5% since hitting a nine-month low of 89.53 in May, as the US economy outperformed its peers and the Fed signaled it was moving closer to tightening monetary policy. The dollar has also benefited from its safe-haven appeal amid rising geopolitical tensions and uncertainty over the global recovery from the pandemic.

Outlook for Other Major Currencies

The dollar’s strength has weighed on other major currencies, especially those that are sensitive to risk sentiment and commodity prices. The Australian dollar, which is often seen as a proxy for global growth, fell to a nine-month low of 0.7286 on Friday, as China’s crackdown on its tech sector and property market dampened investor confidence.

The Canadian dollar also dropped to a six-week low of 1.2768 per US dollar, as lower oil prices and weaker-than-expected domestic data reduced the odds of an interest rate hike by the Bank of Canada this year.

The British pound, meanwhile, held up relatively well against the dollar, trading around 1.3750 on Friday. The pound was supported by upbeat UK retail sales data and hopes that the Bank of England will soon follow the ECB in scaling back its stimulus measures.

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