New high this year! With nearly 10 billion shorts, is this round of strong dolla

In the just-concluded month of August, the US Dollar Index fell by 2.2%, marking the largest decline since November of the previous year, touching the second-lowest point of this cycle of dollar appreciation.

The new round of dollar weakness is associated with market expectations of a shift in Federal Reserve policy. Federal funds futures indicate that the Fed will cut interest rates by nearly 100 basis points within this year. As a result, non-US currencies have rebounded significantly. Data from the US Commodity Futures Trading Commission (CFTC) shows that short positions in the dollar rose to $9.8 billion last week, a new high since January.

The dollar's strong cycle is faltering.

After the Fed began raising interest rates in March 2021, the US Dollar Index initiated a new bull market cycle, reaching a high of 114.7 in September 2022. As prices peaked and declined, the index fell below the 100 mark in June 2023. Subsequently, influenced by factors such as sticky inflation and supply chain bottlenecks, the index entered a range-bound trading pattern. Then, in the second half of this year, stimulated by a sequential decline in inflation to zero, the Fed gradually shifted its policy focus from prices to employment. The September rate cut pricing initiated a new round of dollar dives, and last week, it approached the 100 mark again.

The Chief Investment Office (CIO) of UBS Wealth Management in a report sent to reporters from Yicai predicted that the current strong dollar trend has reached its end. Firstly, the slowdown in US economic growth and consumer spending will weaken support for the dollar. Benefiting from a robust fiscal stimulus plan, strong immigration, and resilient consumer activity, the US economy has remained robust. However, the high savings rate of consumers after the pandemic has declined, and economic data show that consumer spending is slowing down. The labor market is beginning to show signs of weakness, especially in industries that supported job growth after the pandemic.

Secondly, the interest rate advantage of the US relative to other parts of the world will diminish. US inflation, which had been high, is now finally approaching its long-term target. To achieve the dual task of curbing inflation and maintaining full employment, the Fed needs to quickly ease the current restrictive interest rate levels. The decline in nominal and real interest rates in the US will weaken the yield advantage of the US, thereby weakening support for the dollar.

Lastly, investors are turning their attention to structural challenges. Structural issues such as the US fiscal and trade deficits are often overlooked until there is a shift in market sentiment. Slowing GDP growth and declining yields may prompt investors to reevaluate the high valuation of the dollar, as tight government fiscal conditions and balance of payments are not conducive to a strong dollar. History has shown that overvalued currencies are vulnerable when fundamentals change.

The Fed's rate cuts have also provided relief for many central banks in developed economies. In early July, the yen fell to a 38-year low against the dollar, breaking through the 160 mark. The Bank of Japan's several interventions had limited effects under the pressure of dollar buying. With the Bank of Japan's rate hike, the Fed's upcoming rate cuts, and the unwinding of popular carry trades, the yen has rebounded more than 10% from its low, temporarily escaping danger.

Derek Halpenny, the head of EMEA Global Market Research at Mitsubishi UFJ Financial Group, said: "(After the rate cut) it is expected that the US Dollar Index will not frequently adjust and rebound as it has in the past two years. This is a fundamental turning point, and the dollar/yen is heading lower."

Two years ago, the controversial policies of then-Prime Minister Truss led to the pound falling to a historical low, and the euro-dollar exchange rate fell to parity, with the weakening of the local currency also increasing the pressure to deal with inflation.The situation has changed now. The British pound and the euro are the best-performing major currencies this year. The pound has risen above 1.30 against the US dollar, increasing by more than 25% from its historical low, and the euro has recovered to 1.12 against the US dollar last week, thanks to the market pricing of interest rate cuts by the European Central Bank and the Bank of England being lower than that of the Federal Reserve.

The UK's economic growth momentum is strong. The latest data released on Monday showed that the UK's Manufacturing Purchasing Managers' Index (PMI) for August rose to 52.5 from 52.1 in July, the highest level since June 2022, and was in line with the initial value in August. The market expects the Bank of England to keep interest rates unchanged this month and then cut rates in November, which would be the second rate cut since 2020. Bank of England Governor Bailey said in Jackson Hole last month that it is not yet possible to declare victory over inflation, especially in the UK's service sector.

Emerging market pressures ease

For emerging economies, a weaker US dollar can alleviate import-driven inflationary pressures and often provide central banks with more policy space to stimulate economic recovery.

The Chinese yuan just experienced its largest monthly gain in August this year. The central parity rate of the yuan against the US dollar was adjusted up by 222 basis points to 7.1124, and the onshore yuan against the US dollar accumulated a rise of 1380 basis points to 7.0881. The offshore yuan against the US dollar accumulated a rise of 1370 points, once breaking through the 7.08 level.

The appreciation of the yuan in this round is mainly due to the weakness of the US dollar, a situation that may continue, especially if exporters sell their accumulated US dollar reserves. Lynn Song, Chief Economist for Greater China at ING Group, said: "We generally expect the yuan to gradually strengthen." She predicts that by the end of the year, the exchange rate of the US dollar against the yuan will rise to 7, an increase of 1% from the current level.

Liu Jianheng, Senior Economist for Greater China at Standard Chartered Bank, said that the bank's Renminbi Global Index (RGI) continues to strengthen, benefiting from the increased interest of foreign investors in yuan assets, the expansion of the scale of yuan assets held abroad, and the strong issuance of dim sum bonds.

Standard Chartered said that in terms of offshore yuan assets, driven by the improvement of investment sentiment in Hong Kong stocks, the southbound capital flow through the stock connect has rebounded, further expanding the scale of offshore yuan deposits. In May, Hong Kong's offshore yuan deposits recorded a new high of 113 billion yuan. "Recently, with the expectation of interest rate cuts by the Federal Reserve increasing, the depreciation pressure on the yuan has eased. If this momentum continues, we believe it will become a new tailwind for promoting the growth of offshore yuan deposits in the second half of the year."

The weakening of the US dollar has also boosted the currencies of other developing countries in the region, especially in Asia. The Philippine peso achieved its best monthly gain in about 18 years in August, and the Indonesian rupiah achieved its largest increase in more than four years.

With the Federal Reserve cutting interest rates, the monetary policy space for emerging markets is also expected to open up. Korm, Head of Emerging Markets Research at MUFG, said: "We expect that for the rest of this year, the central banks of the Philippines, Singapore, South Africa, South Korea, Taiwan, and Turkey will join the early ranks of Latin America and (Central and Eastern Europe)."