As consumer confidence, housing and jobs markets disappointed in recent weeks, the US currency has fallen back from its recent highs against the euro. The next move, traders say, will depend on how the Federal Reserve reacts, and whether the economy gets worse before it gets better.
Traders in the glass-half-full camp are betting the dollar will rebound in the short term, as investors move away from riskier currencies such as those associated with commodity markets. The Canadian dollar was the preferred short, in particular compared with the New Zealand and Australian dollars.
If risk appetite is further undermined by news of slower economic growth, the dollar was also a good bet against the Swedish krona and the euro, traders said.
For every dollar bull on the Street, however, there is at least one bear, and traders betting against the dollar saw little prospect of the Federal Reserve adding to its two campaigns of quantitative easing.
“If things get really ugly the dollar could benefit, but our core view is that it will weaken because of the trade position, loose Fed policy and economy worries,” said Paul Robinson, Head of European FX Strategy at Barclays Capital.
Those with a negative view on the US dollar should sell the currency against the euro, Chinese yuan, Norwegian krone or, on a short-term basis, Philippine peso or Malaysian ringget, traders said.
Despite continuing wrangles over the Greek debt crisis, traders were cautiously betting the euro would rise in the medium term, expressing that view via long positions against the US dollar and the Swiss franc, which was seen as overvalued by several market participants.
The euro did not have it all its own way, however, with several traders expecting European peripheral sovereign issues to hamper the regional economy and stem further rises in central bank interest rates, after the ECB lifted its key rate in April.
The Swedish krona was the standout pairing for the eurodollar bears, with several banks betting Riksbank rate rises would outpace their euro zone counterparts.
“The Swedish economy is strong, the central bank is free to tighten and the county is not burdened by the European debt crisis,” said Kit Juckes, head of foreign exchange at Societe Generale. “The trade is a little bit crowded but it’s not devastatingly expensive as yet.”
Option strategies
Consensus among many of the top banks came around dollar yen, with most traders expecting the currency to trade in a range, as slow US economic growth is offset by expected Japanese intervention to prevent excessive Japanese currency gains.
Recommended trades to exploit the dollar yen range included range accruals, which pay if a note trades within a specified range for a certain number of days in a set period, or so-called double no-touch options, where the buyer profits if the price does not reach or surpass either of two barriers.
Among emerging market currencies, the Israeli shekel was favoured, particularly against the euro, as was the South African Rand, against both the euro and the Turkish lira. Traders also recommended the Polish Zloty against the Hungarian forint.
Further option trade ideas included volatility plays such as a recommendation to sell dollar volatility against the Norwegian krone or euro dollar, and to buy sterling volatility, reflecting a view that the UK has more potential for economic surprises. Traders also played the dollar Swiss franc volatility smile, betting that out-of-the-money dollar calls should increase in value.
One bank recommends using options to sell the euro against the Swiss franc, taking advantage of the Switzerland’s strong economy and safe haven status. The trade could be executed by buying a euro put option, with a reverse knock-in (RKIs). Due to the extreme skew in EUR/CHF, RKIs are an inexpensive way of increasing downside exposure, says one banks strategist.