HSBC Warns Dollar Rally Could Become 'Explosive' Pain Trade in Second Half
By Aboki Forex —
A sharp rise in the dollar may become one of the biggest pain trades in the second half of the year, according to HSBC Holdings Plc.
The bank expects the dollar to strengthen gradually through the first half of 2027. It warns the rally could turn explosive if the Federal Reserve signals it is ready to tighten policy more than markets have priced in, and if geopolitical tensions flare up again.
The risk has grown since the Fed's June meeting. Policymakers kept their focus on inflation and offered little forward guidance. That has pushed markets back to watching interest rate differentials. It has helped the dollar strengthen against every major currency over the past two weeks.
HSBC analysts including Paul Mackel said in a June 29 report that a stronger dollar would be painful. But they see the pain trade taking the form of a more explosive period of dollar strength.
Bloomberg's dollar gauge hit a seven-month high earlier in June. It was boosted by the Fed's message and strong US economic data. Meanwhile, expectations for tighter policy elsewhere are fading. Europe's outlook has softened as oil prices retreat. The yen has hit a 40-year low on concerns the government wants the Bank of Japan to go slow on further rate increases.
Hedge funds have boosted bullish bets on the greenback to a 16-month high. That is a sign investors increasingly expect further gains.
HSBC also flagged another pain trade: a reversal in the US Treasury market. Investors started the year expecting the yield curve to steepen as the Fed looked set to keep cutting rates. But sticky inflation, a resilient labor market and a more hawkish Fed have flattened the curve instead.
Yields on two-year Treasuries have risen more than 60 basis points this year. That compares with about 20 basis points for 10-year yields. Many investors are positioned for further flattening. But HSBC warns those bets could quickly unravel if the economy weakens enough to push the Fed toward easing. That would trigger a renewed steepening of the yield curve.