Navigating the Uncertain Dollar: Investors Seek Cross-Currency Trades

Investors are increasingly turning to cross-currency trades to avoid the volatility of the US dollar, as the outlook for the Federal Reserve's policy path and the upcoming US elections create significant uncertainty in the foreign exchange market.

Diversifying Beyond the Greenback: A Strategic Shift in FX Positioning

Sidestepping the Dollar Dilemma

Investors are finding themselves in a peculiar position when it comes to the US dollar. Traditionally, the greenback has been the dominant force in the foreign exchange market, accounting for one side of 88% of all trades in the $7.5 trillion-a-day market. However, the current environment has prompted a strategic shift, with investors seeking to minimize their exposure to the dollar and explore alternative cross-currency opportunities.The uncertainty surrounding the Federal Reserve's policy decisions and the upcoming US elections has made it challenging for investors to take a strong directional view on the dollar. As a result, they are increasingly favoring trades that can generate profits irrespective of the dollar's performance, such as shorting the Swiss franc against the Japanese yen or buying the British pound against the New Zealand dollar.

Neutral Positioning and Cautious Approaches

The shift in investor sentiment is evident in the long-term positioning data. According to State Street Global Markets, the trading arm of the US custodial bank, long-term investor positioning in the greenback is the most neutral it has been in two-and-a-half years. This reflects a broader trend of investors holding off on making significant bets on the dollar until the political and economic landscape becomes clearer.Financial institutions like Wells Fargo & Co., RBC Capital Markets, Allspring Global Investments, and State Street Global Advisors are adopting a cautious approach, choosing to delay their dollar bets until later in the year. They cite the political uncertainty surrounding the US elections as a key factor in their decision-making process.

Embracing Cross-Currency Opportunities

As investors steer clear of the dollar, the foreign exchange market is witnessing a surge in cross-currency trades. RBC Capital Markets, for instance, recommends shorting the Swiss franc against the Japanese yen as a play on central bank divergence. Meanwhile, Allspring Global Investments is betting on the euro slumping against the Norwegian krone.These cross-currency trades offer investors the opportunity to profit from market movements without being directly exposed to the US dollar. By focusing on the relative performance of different currencies, investors can potentially generate returns regardless of the dollar's trajectory.

Waiting for Clarity: The Influence of Elections and Fed Policy

The upcoming US elections and the Federal Reserve's policy path are two key factors driving the uncertainty surrounding the dollar. With Vice President Kamala Harris only narrowly leading Donald Trump in the polls, investors are hesitant to make bold bets on the dollar's performance.Similarly, the outlook for the Fed's policy decisions is also a source of uncertainty. Markets are eagerly awaiting further job data releases, as they could provide clues on the central bank's next steps. JPMorgan and Nomura strategists are opting to maintain a light and net-neutral dollar exposure until the labor market data offers better clarity on the rate path.

Navigating the Volatility: Strategies for Weathering the Storm

In the face of these uncertainties, some market participants are exploring alternative strategies to navigate the volatile environment. Jefferies' global head of FX, Brad Bechtel, suggests that buying dollars versus the Mexican peso and Chinese yuan could be a way to play the so-called "Trump trade." However, he acknowledges that beyond these specific bets, traders may choose to stay away from the greenback altogether.Wells Fargo's global macro strategist, Aroop Chatterjee, also notes that the election outcome "particularly clouds the view for the year-end and for early 2025." This uncertainty has weakened his bias for the dollar to gain in the coming months, leading him to favor macro trades like short franc-yen as a way for investors to remain on the fence about the dollar.As the foreign exchange market navigates these uncharted waters, investors are demonstrating a growing preference for cross-currency trades that can provide returns irrespective of the dollar's performance. This strategic shift reflects the desire to minimize exposure to the greenback and capitalize on the relative movements of other currencies, particularly in the face of the political and economic uncertainties that lie ahead.