Asset Managers' Bearish Dollar Bets Backfire Amid Strong US Jobs Data

Key Takeaway

• Asset managers increased net short dollar positions for six consecutive weeks, just before strong US jobs data boosted the dollar.
• The resilient labor market has pushed back expectations for Fed rate cuts, strengthening the dollar against G10 peers.
• Economists are divided on Fed's rate cut signals; potential no-cuts stance could trigger higher bond yields and stronger dollar.

Dollar Surge Amid Strong Jobs Data

The US dollar experienced a significant rally, reaching a one-month high following stronger-than-expected US jobs data. Asset managers had increased their net short dollar positions for the sixth consecutive week, the longest streak since 2022, according to the Commodity Futures Trading Commission data compiled by Bloomberg. However, the robust payroll growth in May, which exceeded all economists' estimates, triggered a surge in the greenback as traders adjusted their expectations for the Federal Reserve's interest rate cuts.

Goldman Sachs strategists, including Kamakshya Trivedi, noted, "A resilient US labor market should help set a firmer tone for the dollar into this week’s Fed policy decision." They further emphasized that the dollar is likely to remain the "safest haven" for portfolio flows amid upcoming election uncertainties and strong asset returns. The Bloomberg Dollar Spot Index continued its upward trajectory, rising for a third consecutive day in early Monday trading in Asia.

Fed Policy and Market Expectations

The unexpected strength in the US labor market has led to a reassessment of the Federal Reserve's policy trajectory. A Bloomberg survey revealed that a 41% plurality of economists predict the Fed will signal two rate cuts in its closely watched "dot plot," while others expect one reduction or none at all. Kathleen Brooks, research director at XTB, highlighted the potential implications, stating, "There is a small risk that they could rule out rate cuts for this year completely due to the strength of the labor market." Such a scenario could "trigger a surge in bond yields, broad-based dollar strength, and weakness for equities."

The upcoming Federal Reserve policy meeting and the release of US inflation data are critical events that could influence market dynamics. The FOMC will update its summary of economic projections and dot plot, which will provide insights into the Fed's future rate path. The market is keenly watching for any signals that could either confirm or alter the current expectations of rate cuts.

Emerging Markets and Election Shocks

Emerging-market investors are shifting their focus to local bonds and relative-value currency trades in response to election shocks that have disrupted long-standing bets in major emerging economies. Asset managers like Ashmore Plc and Ninety One are increasing their positions in local debt, particularly in frontier markets. Christine Reed, a portfolio manager at Ninety One, mentioned, "We’ve been increasing the frontier risk, through both local bonds and FX derivatives."

Turkey has emerged as a favored bet among investors due to its recent economic policy overhaul and the appointment of investor-friendly officials. Valentina Chen, co-head of emerging-market debt at Mackay Shields, noted, "It’s a fundamental story supported by the central bank, which has hiked a lot and the inflation trajectory is coming down." The total foreign holdings of Turkish lira-denominated government bonds have surged tenfold in a year.

Street Views

• Kamakshya Trivedi, Goldman Sachs (Bullish on the US Dollar):

  "We still think the dollar will prove to be the ‘safest haven’ for portfolio flows over coming months amid upcoming election uncertainty and strong asset returns."

• Kathleen Brooks, XTB (Cautiously Optimistic on the US Dollar):

  "There is a small risk that they could rule out rate cuts for this year completely due to the strength of the labor market. That may trigger a surge in bond yields, broad based dollar strength and weakness for equities."