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Commentary: U.S. rate allure sparks record hedge fund dollar buying, euro capitulation

LONDON (Reuters) - Hedge funds are loading up on bullish dollar bets at the fastest pace on record, taking the Fed’s recent hawkish signal on interest rates at face value and going long the greenback for the first time in a year.

Federal Reserve Board Chairman Jerome Powell speaks at his news conference after the two-day meeting of the Federal Open Market Committee on interest rate policy in Washington, June 13, 2018

The flip side of speculators’ burst of love for the dollar is their complete capitulation on the euro: they are liquidating long positions in the single currency also at the fastest pace on record.

The wave of dollar buying from the speculative trading community has helped lift it to its highest level in a year against a basket of major currencies. The question now is how much higher hedge funds and others are prepared to take it.

If their thinking is based primarily on pure interest rate and bond yield differentials, the dollar could strengthen further and push the euro below $1.15. The contrast in messages given by the Fed and European Central Bank this month could not have been starker.

The U.S. central bank indicated it would raise rates four times this year instead of the three it had indicated. The ECB signalled negative rates are here to stay for a long time to come.

Mario Draghi’s eight-year term as ECB president could end in October next year without his ever presiding over an interest rate rise.

The latest Commodity Futures Trading Commission figures show that speculators and hedge funds swung to a net long dollar position worth $10.4 billion in the week ending June 19 from a 7.1 billion net short position the week before.

Not only was that the first net long position since June last year, the $17.5 billion swing was the largest dollar-positive shift since the CFTC began compiling data on FX futures contract positioning in 1999.

That came almost entirely from dollar bets against G10 currencies, which swung a record $17.7 billion from the previous week in favour of the greenback. Nearly half of that was a $7.7 bln reduction in speculators’ net short euro position.

Specs are now net long dollars against all major currencies except the euro, and they slashed their net long euro position by 52,107 contracts to 36,118 contracts in the week to June 19. That’s the smallest long position in over a year and the biggest weekly reduction ever.

As recently as April the net long euro position was a record 151,476 contracts. And there’s a good chance it’s been cut even further, considering the single currency posted its biggest fall in two years after Draghi’s press conference on June 21.

To say relative interest rates and bond yields favour the dollar over the euro is an understatement. The five-year U.S.-German yield spread rose to 309 basis points on June 21, the widest since January 1989.

If hedge funds and speculators have given up shorting the dollar, they haven’t thrown in the towel on selling volatility, CFTC data show.

They increased their net short VIX futures position last week to 57,570 contracts from 53,346. That’s the biggest short since the end of January, just before the ‘volmageddon’ burst in early February when signs of higher U.S. wage inflation sparked concern that the Fed would have to jack up interest rates.

Investors were spooked, but those fears have eased and shorting volatility is once again one of the most popular trades. But it’s not without risk.

Global trade war fears are bubbling up again, pushing the VIX up to 15.2. That’s not super high, but it is up from the 11 handle it had for much of June and is now creeping above its median over the last five years of around 14.6.

Further reading:

*POLL-Low risk ECB extends QE into next year, say economists

*BIS warns of trade war threat but says rates should keep rising

-- The opinions expressed here are those of the author, a columnist for Reuters --

Reporting and graphics by Jamie McGeever; editing by Larry King