The dollar edged higher against its rivals on Monday on the back of widening weakness in the euro, with a broad low volatility environment encouraging hedge funds to add to bullish bets.
While the Federal Reserve has pressed the pause button on its multi-year rate hike cycle, higher U.S. bond yields in relation to peers means the interest rate advantage still lies firmly with the United States, especially against the backdrop of receding fears about the outlook of the global economy.
“Markets still view that the yield pick-up in the U.S. is more than enough to compensate for the pause in policy tightening, but I would be wary of chasing the dollar higher if the global trade backdrop improves,” said Ian Gunner, who runs a currency fund at Altana Wealth in London.
The gap between benchmark 10-year yields in the United States and Germany has widened to a near three-month high of 257 basis points, compared with 240 basis points at the start of the year..
That rise in yields has come amid falling market volatility, especially in currency markets which has enhanced carry trade- seeking strategies involving borrowing in a low yielding currency such as the yen or the euro and buying a higher-yielding one such as the dollar.
Three-month implied volatility in the Japanese yen, a gauge of expected swings in the currency versus the dollar over three months, has flattened to 4 1/2-year lows
Hedge funds have ramped up their long dollar bets, with latest positioning data showing net positions rising to $27.24 billion for the week ending March 1. Most of those bets are positioned to exploit higher U.S. interest rates.
Hopes that some of the world’s major central banks would raise interest rates this year have faded in recent weeks amid tepid economic data. Some analysts now expect a fresh round of bank funding at a European Central Bank meeting later this week that would boost the dollar.
“With so much dovishness priced before the ECB meeting this week, Draghi will struggle to exceed market expectations and this may help the euro,” said Valentin Marinov, head of G10 FX research at Credit Agricole based in London.
The dollar traded at 111.96 yen, near a 10-week high of 112.08 on Friday. Against a basket of its rivals, the dollar was a shade higher at 96.62. It rose 0.4% in February, its biggest monthly rise since October 2018.
Much of the weakness in the London session coincided with a broadly weaker euro. The single currency slipped across the board, falling 0.3% against the dollar and 0.2% against the euro.
Media reports that the United States and China might reach a formal agreement at a summit around March 27 is pushing stocks higher and prompting traders to buy the Chinese yuan and other proxy currencies such as the Australian dollar.
The Chinese yuan ticked up 0.25% to 6.6986 to the dollar in offshore trade, near last week’s 7 1/2-month high of 6.6737. With volatility expected to stay low, hedge funds have also placed bets on emerging-market currencies versus the dollar. Those bets are now at a one-year high.