Is the Depreciation of the US Dollar Just the Beginning? Institutional Investors Start Selling Off USD

Monday witnessed a decline in the US dollar, with the currency on track to experience its largest monthly drop in the past year. As per the dollar index, which gauges the currency against six significant peers, it decreased by 0.2%, hitting 103.20 and was moving towards a monthly loss of over 3%. This is the weakest performance since November 2022.

US inflation cools and interest rates are expected to cut, causing weakness in the US dollar. Consumer Price Index inflation fell to 3.2 percent in October, down from a peak above 9 percent in summer 2022, indicating that US inflation is cooling and resulting in an expectation that the Federal Reserve is done hiking interest rates.

According to the Fedwatch tool from CME Group, traders anticipate that the Federal Reserve will maintain interest rates at their present level until mid-2024 and then introduce cuts during the latter half of the year.

When interest rates fall, it is typically advantageous for stocks, bonds, and cryptocurrencies but unfavorable for the dollar. This is because lower interest rates imply that foreign investors, who are seeking higher returns, can find better opportunities elsewhere, thereby weakening demand for the dollar.

Investors prioritize high returns investment over the US dollar. "We often think about USD performance in the context of its interaction with rate differentials and risk appetite,” wrote Dominic Bunning, head of European FX research at HSBC, in a Monday note prior to the release of the CFTC data. "On this front, the USD is caught between two stools. Much stronger risk appetite, in the form of higher global equity markets, has driven the USD weaker."

The US stock market has been performing well recently, especially with the strong performance of giant tech leading the overall trend and bringing high returns to investors. As a result, investors are increasingly focused on these well-performing assets and are less interested in low-risk investments such as the US dollar.

State Street, a custodian of $40tn of assets, has reported that asset managers are expected to sell off 1.6% of their open dollar positions this month, marking the largest monthly outflow since last November. Analysts are warning that this move by asset managers may just be the beginning of a longer-term trend among investors to decrease their exposure to US assets.

The head of foreign exchange strategy at BNY Mellon, Geoff Yu, has revealed that the firm's clients under custody, which amount to $46tn in assets, have been offloading dollars at an accelerated pace over the past 20 days. They have expressed a preference for investing in currencies such as the Japanese yen, Canadian dollar, and various Latin American currencies instead.

Despite the yen experiencing a decline of approximately 12% against the dollar this year, November has provided some relief as the currency has shown signs of strengthening by roughly 1.5%.

According to Francesco Sandrini, who serves as the head of multi-asset strategies at Amundi, he predicts that the declining trend of the dollar will persist as we approach 2024. The main reason behind this expectation is that there would potentially be less tension between the US and China, resulting in a reduced need for investors to rely on the US dollar as a safe haven.