Hedge Funds Shift to Bearish Dollar Positions Amid Optimism Over US-Iran Diplomatic Talks

Dollar Unwinds War-Driven Strength as US-Iran Talks Gain Momentum

Hedge funds are increasingly downbeat on the dollar as the prospect of renewed US-Iran talks and a possible peace deal have seen the greenback unwind almost all its war-driven strength. Investors added to their bearish dollar trades this month through April 10, based on a proprietary trading model from Morgan Stanley.

At the same time, risk reversals on the Bloomberg dollar index show the premium for call options, the cost to hedge against a stronger dollar, over puts, bets against a weaker greenback, have narrowed this month. This indicates a shift in market sentiment towards a weaker dollar.

The dollar's turnaround has been swift. Bloomberg's dollar index jumped 2.4% in March, its biggest monthly gain since July, as haven demand during the Middle East conflict bolstered demand for the world's reserve currency. However, the gauge has since dropped 1.9% in April, including a seven-day losing streak through Tuesday, as the US and Iran started to discuss a resolution to the six-week old conflict.

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According to Morgan Stanley analysts Molly Nickolin, David Adams, and Andrew Watrous, "The path to a weaker dollar is widening, not narrowing." They wrote in a research report published Tuesday that a ceasefire may be positive for risk currencies in the near-term, but they think medium-term dollar weakness may be more concentrated versus major peers, such as the euro, yen, Swiss franc.

Pressure to sell the greenback began building last week after an initial two-week ceasefire was announced, triggering the biggest one-day decline in the Bloomberg dollar index in more than two months. "The hedge fund community had been waiting to sell the dollar, and the first ceasefire proved the catalyst," said Antony Foster, head of Group-of-10 spot trading at Nomura International Plc in London.

Trading in euro-dollar call options of €100 million ($118 million) or more was 50% bigger than that of puts on Tuesday, according to data from the Depository Trust & Clearing Corp. Call options profit from euro gains, while put options rise if the dollar strengthens.

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Asset manager SGMC Capital Pte in Singapore was among those who took advantage of the dollar's gain in March to add bearish bets, according to chief executive officer Massimiliano Bondurri. "We have been using the recent dollar strength to gradually add to bearish positions, as we expect any eventual de-escalation to weaken the greenback," he said.

There's scope for further dollar declines if a more durable truce is reached, Bondurri said, identifying preferred trades including selling the US currency against the Australian dollar, Mexican peso, and Brazilian real.

While there's still uncertainty over how long the US-Iran war will last, there are increasing prospects that it may end up doing more harm than good to the dollar. "Net-net, the dollar appears to be emerging worse-off from the conflict," JPMorgan Chase & Co. analysts wrote in a client note published last week. In the medium term, the greenback might "make another run toward the year's lows," they said.