Bets Against Dollar May Prove Pain Trade as Fed's Dovish Days Nearing End

© Reuters.

By Yasin Ebrahim

AiVIF.com – The dollar stuttered Monday following a slip last week but those betting on the revival of a bearish trend in the greenback need to think again as the Federal Reserve's dovish days are numbered, Morgan Stanley (NYSE:MS) said.

The U.S. dollar index, which measures the greenback against a trade-weighted basket of six major currencies, rose 0.03% to 91.87.

The dollar has struggled to hold onto its upward momentum that was sparked by the Federal Reserve's hawkish tilt earlier this month amid a general malaise in the FX market as liquidity remains abundant.

"The hawkish Fed meeting of June 16th saw volatility rise for just two days and that move has been completely reversed. If the search for yield amidst low volatility is akin to an oil tanker, clearly changing its course will require a lot of work," ING said Monday.

But while the unwind of easy monetary policy faces a long road ahead, the Fed is more likely to tighten monetary policy than ease – and that could prove a tailwind for the dollar.

"[W]e disagree with the notion that there wasn't an important message for the market [from the Fed's June meeting]," Morgan Stanley said in a recent note. "We think the important message for the market is this: investors can no longer assume that the Fed is going to be dovish, no matter what happens to inflation."

"This is important because much of the rationale to be short the US dollar has been based on the idea that the Fed will remain dovish, even as inflation moved higher and higher," it added.

The backdrop of commentary from FOMC members in the weeks that followed the June meeting showed a willingness from a growing number of Fed members to project rate hikes to curb expectations for higher inflation. "This undercuts the primary reason to be short the USD," Morgan Stanley added.

The value of the net short dollar position fell to $12.80 billion in the week ended June 22, compared with a net short of $18.99 billion the previous week, according to U.S. Commodity Futures Trading Commission data, released Friday.