Slumping FX Funds Bet on Soft Dollar, Emerging Mkts

By Gertrude Chavez-Dreyfuss

NEW YORK, March 30 (Reuters) - Currency funds expect to end the first quarter on a sour note, but hope that a weak dollar trend widely expected later this year and lucrative emerging market trades will break their slump.

The Barclay Group Top FX index, a measure of currency funds' rate of return, was down 2.3 percent as of March 29. Most of the funds included in the index trade currencies from the Group of Seven (G7) industrialized economies.

Fund managers, who tend to follow trends, blamed a market that meandered aimlessly and traded in narrow ranges for their first-quarter losses.

By contrast, funds investing in higher-yielding emerging market assets have posted positive returns so far, according to the latest data available.

Barclay's emerging markets index was up a sharp 8.60 percent through February, although this could fall by the end of the quarter as March has been generally a weak month for the market. Emerging equities and currencies sold off for a few sessions in March, amid prospects of global monetary tightening that could diminish the allure of these higher-yielding assets.

For G7 currencies, trading has been mostly a challenge, fund managers say.

"The currency world has been very rangebound in the first quarter and it was very difficult to trade. There were very few prolonged trends," said David Greenwald, a partner at short-term currency fund Scalene Capital Management in Newport Beach, California.

Hedge funds tend to lose money when currencies are confined to narrow trading bands, or when the direction suddenly reverses. Both trends have been evident in the market this year.

"I think positioning for the big move has been a disappointment," said William Lipschutz, director of trading at currency manager Hathersage Capital Management in New York. The firm manages about $150 million in currency assets.

Hathersage is one of few currency managers expected to end the first quarter with a positive rate of return. Its flagship program, which has a longer time horizon, was up around 4 percent since January this year.

"People also need to recognize that we're not in a trending market and so they should manage positions looking for a smaller move. And then you get out," Lipschutz said.

The Euro has traded within a broad range of $1.2330-$1.1800 against the dollar this year and gained about 2.4 percent since the start of the year. Traders say this pairing has been particularly baffling because of mixed U.S. and euro zone economic data on top of initially conflicting interest rate signals from the European Central Bank.

Money markets, however, have priced under the assumption that the ECB would raise rates in May amid recent strong euro zone data. Euro zone interest rates are currently at 2.5 percent.

DESPITE FED HIKE, MARKETS RELUCTANT TO HOLD LONG DOLLARS

The Federal Reserve, on the other hand, raised interest rates to 4.75 percent on Tuesday in its 15th consecutive hike and suggested further policy firming is needed. That fueled a broad dollar rally, as it preserved the currency's yield attractiveness to global investors.

Yet, few market players are willing to bet on continued dollar gains, as they anticipate the end of the Fed's tightening cycle.

"I doubt that the latest FOMC (Federal Open Market Committee) statement will change the general reluctance to build long dollar medium-term exposure," said Alan Ruskin, head of international strategy at RBS Greenwich Capital in Greenwich, Connecticut.

Long dollar positions are effectively bets the currency will strengthen.

"One of the features of this market is the tenacity of the negative medium-term dollar view, predicated upon the U.S. current account deficit story. he added.

The record U.S. current account deficit, a measure of the country's investment and trade flows, is currently running around 7 percent of gross domestic product. The U.S. economy needs about $2 billion in daily inflows to bridge that shortfall, and for this reason the current account gap is viewed as dollar-negative.

To be sure, most hedge funds are hoping that the dollar will resume its weakness soon, which could put them back on track.

John Taylor, chairman of $12-billion hedge fund FX Concepts in New York, believes the strong dollar phase should end this year, but notes that fundamental barometers do not suggest a reversal just yet.

Currency funds are also hoping their emerging market bets would continue to yield positive results for them, despite their brief meltdown a few weeks ago. At the end of the day, their improving fundamentals should enable them cope with wild market fluctuations, analysts say.

"I know that some of the smart investment banks are spending a lot of time and money doing research and getting people interested in ... Brazil, Mexico, China. I expect emerging markets to be very active" said Scalene's Greenwald.

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