Dollar dominates as inflation heats up

A money changer counts U.S. dollar banknotes at a currency exchange office in Ankara

By Saqib Iqbal Ahmed

NEW YORK (Reuters) - Surging inflation and expectations of a potentially more hawkish Federal Reserve are accelerating a rally in the U.S. dollar, buoying the currency to a near 16-month high against its peers and putting it on pace for its biggest annual gain in six years.

On Monday the U.S. Dollar Currency Index rose 0.3% to 95.437, its highest since July 2020.

Graphic: Dollar rebound

A number of banks including HSBC, Citi and JPMorgan have in recent days forecast more gains for the greenback, as Wall Street gauges whether rising inflation will push the Fed to speed up the unwind of its bond-buying program and raise rates more aggressively than expected.

Here is a look at some factors driving the dollar's rally.

Graphic: Inflation and real yield advantage


Inflation has run hotter than expected in recent months, bolstering the argument that the Fed will have to act more aggressively to tame rising consumer prices. Higher U.S. rates tend to make some dollar-denominated assets, like Treasuries, more attractive to yield-seeking investors.

The U.S. Dollar Currency Index jumped nearly 1% last Wednesday, its largest one-day move in nearly five months, after data showed U.S. consumer prices posted their biggest annual gain in 31 years last month.

"The dollar may be in the early stages of an uptrend if higher inflation should prompt the Fed to retire its bond buying program and raise interest rates ahead of current market expectations," said Joe Manimbo, senior market analyst at Western Union Business Solutions.

The U.S. dollar index has appreciated at the start of the last four of the Fed’s hiking cycles, with a mean gain of 3.1% in the first seven months, economists at Citi noted in a recent report. The bank expects the Fed to speed up the unwind of its $120 billion a month bond buying program in January as inflation pressures mount.

UBS Global Wealth Management analysts, meanwhile, believe a comparatively more hawkish monetary policy from the Fed could push the euro to $1.10 by the end of 2022, from $1.14 on Monday.

Graphic: Bullish on the buck


Net bullish positions on the dollar in futures markets have edged lower in recent weeks, though at $19.51 billion they still remain near recent highs after flipping from bearish in mid-July, according to calculations by Reuters and U.S. Commodity Futures Trading Commission data released on Nov. 5.

BofA Global Research's Bull-Bear Index for exposure and view, which tracks fund managers' responses on FX surveys, recently stood close to its highest level since December 2016, indicating bullishness on the U.S. currency.

The index, which moderated slightly recently, is likely to have readjusted after the latest inflation data, BofA Global Research strategists said in a note last week.

"Positioning is not stretched here, but has unwound the 2020 shorts," the strategists wrote.

Graphic: Dollar dominance


A strong dollar can be particularly troublesome for emerging markets, making it more expensive for developing countries to pay down debt denominated in the U.S. currency.

The dollar is up 35% against the Turkish lira this year and has gained 5% against the Brazilian real. The MSCI Emerging Market Currency Index is up 0.9%, on pace for its smallest annual gain in three years.

On Monday, the lira touched a fresh all-time low against the dollar as concerns of another rate cut from the central bank this week continued to weigh on the currency.

"The Fed is starting to tighten monetary policy, worries around China and the pandemic persist, and many emerging markets won’t be able to keep up with the sound growth outlook for developed markets," Tilmann Kolb, analyst at UBS Global Wealth Management said in a note last week. "We think this means more weakness against the U.S. dollar."

Graphic: Bitcoin boom


Inflation fears have raised the allure of other assets, including oil, metal and other raw materials. Some analysts believe they have also contributed to the recent rise in bitcoin, which hit a fresh record earlier this month. The world's largest cryptocurrency by market capitalization is up 120% in 2021.

(Reporting by Saqib Iqbal Ahmed; Editing by Ira Iosebashvili and Andrea Ricci)