Is Buying Dollars in 2016 a Smart or Foolish Trade?
2015 has been a great year for the U.S. dollar but with only 5 trading days left many investors are wondering if being long dollars in 2016 is still a smart trade. December has been a difficult month for the greenback with dollar bulls struggling to maintain control. The Federal Reserve raised interest rates for the first time since June 2006 but instead of appreciating, the dollar erased nearly all of November’s gains. Now many investors are wondering that if a rate hike and hawkish forward guidance can’t lift the dollar, is it foolish to be buying greenbacks in 2016.
To answer that question we have to understand why investors sold dollars in December. The bet that the dollar would rise in 2015 was one of the world’s most crowded trades and according to the CFTC’s Commitment of Traders report, forex futures traders were busy adjusting positions ahead of the December 16 FOMC meeting. The biggest changes were in euro and yen where investors aggressively cut their short euro and short yen positions. This means that investors started to unwind their long dollar trades ahead of FOMC and based on the price action after the meeting, liquidated further after the rate hike. Buying dollars became a very crowded trade in 2015 and a lot of money moved to the sidelines at the end of the year.
This means there’s money to put back into play in 2016.
Yet positioning was not the only reason why investors bailed out of the greenback. According to the following chart past tightening cycles have not been good for the dollar and this scared many investors. While USD/JPY generally appreciated leading up to the rate hike, on a number of occasions it reversed course after tightening but this cycle is different because the first few months of the year will be good for the U.S. economy and the dollar. The warm El Nino weather and low gas prices will boost consumer consumption, which is already supported by steady job creation, wage growth and consumer borrowing. The Fed also welcomes new hawks to their roster of FOMC voters.