Suddenly, "shorting the US dollar" has become a "pain trade."
In the foreign exchange market, with a daily trading volume of $9.6 trillion, shorting the US dollar was the dominant trading strategy this year, but this bet is starting to face setbacks. The dollar has risen to about a two-month high against most major currencies, even as the US government shutdown continues.
On October 10, reports indicated that Asian and European traders said hedge funds are increasing their options positions, betting that the dollar’s rebound will extend until the end of the year. Overseas market trends have become key drivers, with the euro and yen plunging sharply this month, while Fed officials have expressed caution about further rate cuts, boosting the dollar’s appeal.
Analysts say the longer this trend persists, the more painful it will be for investors who insist the dollar will fall further. Currently, Wall Street giants like Goldman Sachs, JPMorgan Chase, and Morgan Stanley are among the dollar short camp. If dollar strength continues, it could have a chain reaction on the global economy, including making it harder for other central banks to ease monetary policy, raising commodity costs, and increasing the burden of dollar-denominated external debt.
In addition, the dollar’s rapid rebound could overturn this year’s most favored trading strategies, dampen fourth-quarter optimism regarding emerging market equities and bonds, and put pressure on US exporters’ stock prices.
Fed Rate Cut Expectations Are Too Aggressive
Uncertainty about Federal Reserve policy trajectory is becoming the core driving force for dollar strength. Traders currently expect about two 25-basis-point rate cuts by the end of the year, with more cuts next year. However, recent events including the September Fed meeting minutes and statements from policymakers indicate that the rate cut path is far from certain.
Ed Al-Hussainy, portfolio manager at Columbia Threadneedle, represents the dollar bears who have changed their views. He shorted the dollar as it rose on the so-called "Trump trade" at the end of 2024, but over the past month and a half, has adjusted his stance by reducing emerging market exposure.
"We’ve become more positive on the dollar. The market has already priced in a very aggressive series of rate cuts, but it’s hard to implement these cuts without more pain in the labor market."
Since mid-year, the Bloomberg Dollar Spot Index has risen about 2% after experiencing the steepest drop for the first half of the year in decades. In early 2025, after President Trump’s inauguration and a temporary hold on full-scale tariffs, the dollar fell for a while, partly because the market expected inflation would be mild enough for the Fed to resume rate cuts.
The government shutdown has delayed the release of key employment data, although the Bureau of Labor Statistics reportedly has recalled employees to prepare important inflation reports. Analysts say evidence of labor market weakness may reactivate dollar short trades.
Renewed Overseas Political Risk Fuels Dollar’s Safe-Haven Demand
The earlier decline in the dollar was exacerbated by improved overseas market prospects, with investors expecting capital to flow into non-US markets. But political situations in France and Japan disrupted this narrative.
In Japan, the prospect of Sanae Takaichi becoming prime minister has worried markets, as her policies are expected to drive up inflation and stimulus measures based on debt, a scenario which pushed the yen to its weakest level since February.
In France, President Macron’s government remains in crisis, placing fresh pressure on the euro, which has fallen to its lowest level since August.
Carol Kong, strategist at Commonwealth Bank of Australia, believes that given the situation in France and expectations of more accomodative fiscal and monetary policy in Japan, the dollar’s rebound against these two currencies may continue.
Andrew Brenner, vice chairman of Natalliance Securities in New York, said:
"The truth is, as we say, the dollar is relatively the least dirty shirt in the laundry basket. With both the yen and euro under pressure, don’t expect a major drop in the dollar."
Options Market Shows Growing Bullish Sentiment
According to Mukund Daga, Global Head of FX Options at Barclays Bank, hedge funds are increasing bullish option trades on the dollar against most G10 currencies, betting the rally will continue until year-end. Option traders are paying more to hedge against dollar upside risk than downside risk.
Depository Trust & Clearing Corporation data shows that every day this week, market demand for bullish dollar structures has exceeded bearish structures. An indicator measuring the demand gap between bullish and bearish bets shows traders’ optimism for the dollar at its highest level since April.
However, the latest data from the US Commodity Futures Trading Commission shows that as of the end of September, hedge funds, asset management companies, and commodity trading advisors still hold short dollar positions.
Analysis points out that although the size of these positions has dropped sharply from the mid-year peak, if the dollar continues to appreciate, there is still considerable room for pain.
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