Paying Most Since ’08 on Dollar Hedges Works as Currency Plunges

(Bloomberg) — Anyone wondering why you’d pay the highest prices since 2008 to hedge against declines in the dollar found out last week when the currency slid the most in more than three years.

The Bloomberg Dollar Spot Index, which tracks the greenback against 10 major currencies, slid 2.2 percent last week. The rout came as options on the PowerShares DB US Dollar Index Bullish Fund reached the most since December 2008 relative to those on the SPDR S&P 500 ETF Trust, one-month data compiled by Bloomberg show.

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Shares of the U.S. currency’s exchange-traded fund plunged the most in five years on March 18 after the Federal Reserve cut its projections on where interest rates will be by the end of this year and cited softer economic growth. Peter Cecchini at Cantor Fitzgerald LP recommended clients buy bearish options on the ETF before the U.S. central bank’s decision, then sell them after.

“I knew that if the Fed had come out slightly more dovish than expected, the dollar would snap down because so many people are long,” Cecchini, the New York-based chief strategist and global head of macro equity derivatives at Cantor Fitzgerald, said by phone March 19. “It’s run too far, too fast.”

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Central Banks

The cost of options on the Powershares ETF rose to 0.91 times those on the SPDR S&P 500 fund March 18, one-month Bloomberg data show, the highest ratio since December 2008. Since then, the relationship has increased to 0.95 times as hedging costs on the dollar fund have risen higher relative to those on the S&P 500 ETF.

The dollar’s ascent this year has been fueled by the Fed’s plans to raise borrowing costs at a time when central banks from the euro area to Japan and Canada are forging ahead with stimulus programs. The Bloomberg dollar gauge, which is weighted against peers in its group including the euro and yen, has rallied as much as 8.1 percent this year to the highest since at least 2004 on March 13.

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Fed Chair Janet Yellen said on March 18 the strong dollar has weighed on consumer prices and contributed to weak export growth and low import prices. The central bank said higher interest rates in April are unlikely and it won’t tighten until it is “reasonably confident” inflation will return to its target and the labor market improves further. That day, the Bloomberg dollar measure dropped the most in six years.

Disappointing Data

“You can get snafus like the Fed going out and unexpectedly changing its forecast and softening its interest rate projections, which cause massive knock-offs in sentiment,” Andrew Wilkinson, chief market analyst at Interactive Brokers LLC in Greenwich, Connecticut, said by phone March 19.

Economic reports in the U.S. have fallen short of prognosticators’ expectations by the most in six years. The Bloomberg ECO U.S. Surprise Index, which measures whether data beat or miss forecasts, fell to the lowest since 2009 last week.

Signs of disappointing growth, coupled with improving data in Europe, show the dollar may incur more losses, according to HSBC Holdings Plc strategists led by David Bloom. The divergence in monetary policy worldwide is already priced into the currency, they wrote in a March 19 note.

“We believe the U.S. dollar rally is nearing its end,” the strategists wrote. “The U.S. dollar has already rallied more than is typical historically, and many of the arguments currently being used to justify an extension are likely already in the price.”

Jobs Report

The U.S. currency jumped to a 12-year high relative to the euro earlier this month after a better-than-forecast report on the labor market fueled speculation that the Fed would tighten its stance on increasing interest rates. The unemployment rate dropped to the range the central bank considers to be consistent with stable inflation.

While the dollar may be vulnerable to bigger swings, the currency will still strengthen in the long run this year if the Fed raises interest rates, according to Pravit Chintawongvanich at Macro Risk Advisors.

“I think the dollar continues to strengthen, but we could see more volatility,” Chintawongvanich, a New York-based derivatives strategist at Macro Risk3, said by phone March 19. “The Fed is still on track to hike this year, while other countries are easing. The U.S. is one of the only countries allowing their currency to strengthen. The Fed considers dollar strength in deciding whether to hike rates, but they won’t intervene directly.”

Short-sellers are also betting the dollar’s rally is running out of steam. The number of shares shorted in the currency fund has soared more than 370 percent this month to the highest since July 2012, data compiled by Markit Ltd. show.

Traders own 2.1 bearish options for every bullish one on the ETF, the highest put-call open interest ratio since April 2009, according to Bloomberg data.

Shares of the fund slid 2.5 percent to $25.82 last week. The most-owned option on the ETF is a wager for shares to fall 3.2 percent by June 19.

“Anything that’s run as far and as fast as the dollar has typically needs to consolidate those gains,” Bruce McCain, who helps oversee more than $25 billion as chief investment strategist at the private-banking unit of KeyCorp in Cleveland, said by phone March 19. “Some pullback and basing out would make sense.”

To contact the reporter on this story: Callie Bost in New York at cbost2@bloomberg.net

To contact the editors responsible for this story: Jeff Sutherland at jsutherlan13@bloomberg.net Chris Nagi

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