US dollar draws strongest backing in a decade

Global investors are the most bullish they’ve been on the US dollar for a decade, pointing to major shifts in the forces driving the US currency.

The improved US economy, expected future US energy independence and the expectation that the US dollar is increasingly correlating with riskier financial assets are partly behind a surge of confidence in the dollar's fortunes. Fund managers are the most bullish they've been on the dollar for 10 years, according to a survey from Bank of America Merrill Lynch – with a net 72% expecting the currency to appreciate over the next year – while global banks are adjusting their forecasts to anticipate a stronger dollar.

The US dollar index, weighing the dollar against a basket of currencies, has rallied hard this year, up 7.3%. 

‘Relative US economic outperformance on the back of the housing market’s ongoing improvement and the energy independence story will lead a secular uptrend in the dollar,’ Michael Hartnett, chief investment strategist at Bank of America Merrill Lynch Global Research said at a press briefing today.

Transition to new dollar

Strategists at Morgan Stanley reckon the dollar will no longer be a currency with a low interest rate used to buy one with a higher rate in the so-called ‘carry trade’. ‘We expect FX to enter a transition period, with the USD rising as it converts from a funding currency into an asset currency’, they wrote in their Spring outlook report published yesterday.

‘The dollar will be the star of FX this quarter’ said Kathleen Brooks of Forex.com. The currency strategist agreed that US energy independence ‘will have a massive impact on the dollar in the long term’, while the declining US deficit will also help the currency.

ABN Amro Private Banking agree. ‘Under the surface, sentiment on the US dollar appears to be changing’, says the bank's Georgette Boele. With both eurozone and US official rates near zero, ‘the choice leans to the currency with better economic growth and valuation,’ she adds.

US stocks increasingly popular too

Uniquely, this optimism about the US dollar is accompanied by upbeat forecasts about US shares, which normally could be expected to benefit from dollar weakness.

The Bank of America survey shows a shift from an underweight on US stocks to an overweight position, as the eurozone returns as the biggest ‘tail risk’ for the first time in six months.

Strong corporate earnings, ongoing support from the Federal Reserve and the improving US economy are lending support to US shares.

The preference comes despite the strong rally in US stocks so far this year. ‘We prefer the US over Europe; relative valuations in Europe are now less compelling, and while base case returns are similar, the US has less downside risk,’ says the Morgan Stanley report.

Brooks says the US economy is in a ‘sweet spot’.

‘Companies are hiring and the housing sector has finally worked its way through some of that bad debt. We need to see home data continue to do well for the recovery to be sustained.’

Detractors

Private investors aren’t so enthused by the prospects for the US though, with just 12% of them telling a survey by the Association of Investment Companies (AIC) that North America is the most attractive region to invest in, behind the UK, emerging markets and Asia Pacific.

And a poll by Reuters of 45 strategists showed more subdued expectations for US stocks. They expect the S&P 500 to end the year at 1,600, a 12% increase on the year but just a 3 % rise from Monday's close of 1,552.10, Reuters notes.