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Montly Wrap Up | DEC


Investment Institutions Begin Rapidly Selling the Dollar in Q4

Investors are shedding the U.S. dollar at the fastest pace in a year since reaching the annual high of 107.34 in early October. This rapid selling is fueled by the belief that the Federal Reserve has concluded its aggressive tightening measures and is poised to cut interest rates multiple times next year. Notably, State Street, overseeing $40 trillion in assets, indicated that asset management firms were expected to sell 1.9% of their open, unhedged U.S. dollar positions last month, marking the largest monthly outflow since November of the previous year.

The significant selling began after the U.S. reported non-farm payroll data weaker than expected on November 3rd. Asset managers have been engaged in "significant" selling activities daily since then. This trend is contributing to the potential worst monthly performance for the U.S. dollar in a year. The selling by asset management firms may signify the initiation of a long-term trend of reducing exposure to U.S. assets. Recent fund flows over the past two weeks suggest a rapid reassessment of the demand for the U.S. dollar by investors. The recent sell-off in the dollar signals the unwinding of "exceptionally large-scale dollar overallocation" positions, as investors believe holding fewer dollars is prudent if rate cuts materialize.

Data shows that such rapid reductions in holding the dollar have occurred only six times in the past 20 years, with the most recent instance in November of the previous year, during which the U.S. dollar index fell by approximately 10% in just three months through the end of January this year. Despite recent selling, asset management firms remain overweight on the dollar relative to other currencies, suggesting the possibility of further weakness in the U.S. dollar.

Last year, driven by the Federal Reserve's rate hikes, the U.S. dollar experienced a significant bull market. By the end of September, the U.S. dollar index had surged by 19%, bringing substantial profits to macro hedge funds holding bullish positions. However, in the fourth quarter of this year, the U.S. dollar has seen a substantial decline.

From July to October this year, robust economic data pushed the U.S. benchmark borrowing cost to a 16-year high, leading investors to believe that interest rates would remain elevated for an extended period. The U.S. dollar index surged over 7% during this period. However, recent weeks have seen a shift in this narrative. In October, U.S. inflation dropped to 3.2%, exceeding expectations, prompting investors to dismiss the possibility of further rate hikes. The derivatives market currently anticipates the Federal Reserve cutting rates by 0.75 to 1.0 percentage points before September next year.

If recent lackluster economic data continues, the U.S. dollar may continue its overall downward trend. The recent weakness has kept the U.S. dollar index roughly flat compared to the levels at the beginning of this year. Over the past half-month, investors and asset management firms have been selling the U.S. dollar at the fastest pace this year, favoring purchases of the Japanese yen, Chinese yuan, and various Latin American currencies.

The selling pressure on the U.S. dollar is seen as good news for the Japanese Ministry of Finance and the People's Bank of China. Additionally, this is an opportune moment to consider two currencies that can be absorbed, as suggested by the author before the year-end.

Earlier this month, the exchange rate of the Japanese yen against the U.S. dollar approached a 32-year low, raising the cost of imported goods in Japan and increasing inflationary pressures. The Japanese government has been on "red alert" for the possibility of intervening in the foreign exchange market.

Although the yen has fallen by about 12% against the U.S. dollar year-to-date, it has appreciated by about 2.3% since November, easing some depreciation pressures. The yen is expected to continue strengthening as investors widely anticipate the Bank of Japan canceling its negative interest rate policy in the coming months, making shorting the yen less meaningful.

As for the Chinese yuan, with the weakening of the U.S. dollar, the yuan showed a robust rebound in November, appreciating significantly against the U.S. dollar onshore and offshore, with gains of around 200 basis points. This marked a new high in over five months, with onshore and offshore yuan both hovering around 7.13. Looking ahead, most industry insiders believe that the upward trend in the yuan's exchange rate may not be over. In November, both onshore and offshore yuan rates against the U.S. dollar, breaking the previous two months of sideways movement, experienced a sharp rebound, with gains exceeding 2.5%. The substantial appreciation of the yuan has three main reasons: first, the U.S. dollar index's depreciation by over 3% this month favors the yuan's appreciation against the U.S. dollar; second, the market anticipates the end of the Federal Reserve's interest rate hiking cycle this year, with rate cuts expected next year, which suppresses the U.S





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