Just when investors thought they’d finally made a good call in the currency market, the dollar’s advance messed it up.

The U.S. currency on Friday capped its best week all year versus its major peers, shortly after hedge funds finally switched to betting on dollar declines, known as going short. That’s not the only wrong move foreign-exchange managers have made this year—an index tracking their returns shows they’ve failed to turn a profit in 2016.

"There's a lot of uncertainty about the strength of U.S. growth; there's still a lot of risk expectation built around China, and those two forces working against each other means we don't have a strong trend." --Philip Moffitt, Goldman SachsMany of the assumptions traders made at the start of the year turned out to be misguided. Anticipated Federal Reserve interest-rate increases have failed to materialize, creating less policy divergence between the U.S. and its counterparts. And though investors were right to speculate the pound would tumble in the run-up to next month’s European Union referendum, it’s recovered since.

“It’s been a very challenging year in the currency market given the lack of solid fundamental themes and the difficulties for some market-consensus trades which haven’t worked,” said Chris Chapman, a London-based trader at Manulife Asset Management (Europe) Ltd., which oversees $325 billion. “A lot of people were expecting a lower euro, lower yen, and higher dollar, but the market moves have so far been against those expectations.”

The lack of profit comes at a difficult time for the foreign-exchange market. Banks including Morgan Stanley, Barclays Plc, and Societe Generale SA have cut traders from their currency desks as they grapple with a 20 percent drop in volumes in the past 18 months amid increasing automation. And it’s not just currency trading that’s suffering: Global stocks are headed for a second straight year of losses, following a rout in January and February that wiped out as much as $9 trillion.

The  volatility that currency traders need to make money is averaging the most in five years, but it’s largely been caused by tough-to-predict, and therefore hard-to-profit-from, events such as surprises from leading central banks. A measure of global price swings has averaged 11 percent since Dec. 31, more than in the same period of any year since 2011.


‘Absolute Conviction’ Proved Wrong in Currency Markets

“Just think about when we entered the year,” said Alessio de Longis, a New York-based money manager in the global multi-asset group at OppenheimerFunds Inc., which oversees $216 billion. “The absolute conviction in the Street was—oh, the European Central Bank’s gonna do more quantitative easing [QE], so being short the euro is a no-brainer,” he said.

“Japan’s gonna do more QE, so being short the yen’s a no-brainer. Brexit is a serious risk, so being short the pound is a no-brainer. Where are all those trades today? All those things have been wrong, or tested very severely.”

De Longis’s favorite strategy now involves buying higher-yielding emerging-market currencies reliant on commodity prices—both of which have rallied this year in a surprise to many.

Hedge-fund data suggest investors have been slow to back emerging-market currencies after a January rout, leaving them less able to profit from the best year-to-date performance since 2011.

Tracking the Mexican peso as a  proxy for its less-traded peers shows speculators have been betting on declines all year, paring net shorts only gradually, based on data from the Commodity Futures Trading Commission (CFTC) in Washington. This helps explain why the Parker Global Currency Manager Index of fund returns is almost flat since the start of 2016, even as a Bloomberg gauge of 20 emerging-market currencies jumped more than 4 percent.


Currency Markets Head Off-Trend

One challenge is that it’s been difficult to identify and latch onto trends, with an index of momentum trading up less than 1 percent this year. At the end of December, the Fed predicted it would raise rates four times in 2016, but it has since cut its forecast. As a result, the Bloomberg Dollar Spot Index fell almost 6 percent through April, paring three years of gains.

Currency managers are now in danger of missing out again as sentiment starts to turn. The Bloomberg dollar index climbed 1.5 percent last week as talk of a June rate increase re-emerged. Yet speculators extended net-short positions on the greenback versus eight major currencies to the most since April 2014 in the week ended May 3, CFTC data show.

After trimming bets that the U.S. currency would strengthen against the euro and yen, Goldman Sachs Asset Management is now wagering on declines in Asian currencies including South Korea’s won, Taiwan’s dollar, and Malaysia’s ringgit amid a slowdown in China.

“There’s a lot of uncertainty about the strength of U.S. growth; there’s still a lot of risk expectation built around what’s happening in China, and those two forces working against each other means we don’t have a strong trend,” said Philip Moffitt, the Sydney-based head of fixed income for Asia Pacific at the Goldman Sachs unit, which oversees more than $1 trillion. “The last six months or so have been much more difficult.”

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