By Wanfeng Zhou - Analysis
NEW YORK (Reuters) - The one-way bet in the U.S. dollar that has lasted several months may be over for now despite distress over its malaise that has stretched from Washington to Paris.
The dollar recently hit a 15-month low against a basket of other major currencies. This weakness has become a political football in the United States, as opponents of the Obama administration charge that it shows fiscal policy is hurting the U.S. economy. Other countries have also become increasingly vocal about the dollar’s decline.
Even Federal Reserve Chairman Ben Bernanke commented on the dollar, saying on Monday that the Fed does watch the dollar’s value.
But the greenback has shown resilience in recent days. Activity in the options market, valuation measures and a slight divergence in the tight relationship between stocks and the dollar suggest a possible end to dollar weakness.
There is growing nervousness that the rally in risky assets is overdone, with experts questioning whether the rebound in the global economy can go on without government support.
“A lot of good news is already priced in. For the dollar to meaningfully break below these levels, we’ll probably have to see something that adds significantly to the already upbeat outlook for the global economy,” said Omer Esiner, senior market analyst at Travelex Global Business Payments in Washington.
Selling the dollar to buy stocks, commodities and higher-yielding currencies has been a popular trade of late as low U.S. interest rates and an abundance of liquidity have lured investors into riskier assets in search of returns.
The dollar fell to a 15-month low against a currency basket this week and is down 15 percent since March. It also hit a 14-month trough versus the euro at 1.5064 on electronic trading platform EBS in late October.
But the euro’s struggle to stay above the key $1.50 level may be a sign the market is overextended. The single currency pierced $1.50 for the first time this year on October 21 and closed above it for three straight sessions. It last hit that level on Monday, trading lately at $1.4852.
“The markets have gotten so choppy. Even if the euro breaches $1.51, I‘m not entirely sure there’s a strong enough risk appetite to chase it much higher,” said Amelia Bourdeau, senior currency strategist at UBS in Stamford, Connecticut.
She expects the dollar’s rebound to continue into year-end as investors take risk off the table and close out their bets against the currency. She expects the dollar to strengthen to $1.45 per euro in one month and $1.40 in three months.
To keep bears on their toes, Bernanke -- in rare comments on the value of the dollar -- said on Monday that the U.S. central bank is monitoring currency markets “closely” and is “attentive” to the implications of a falling dollar.
His comments, which were backed by European Central Bank chief Jean-Claude Trichet, helped boost the dollar this week. But analysts caution that without a change on the policy front, the impact of verbal attempts to talk up the dollar are likely to be short-lived.
David Gilmore, a partner at FX Analytics in Essex, Connecticut, called the remarks “an introduction of two-way risk, even if in a fairly discreet fashion.”
He added that there is “nothing credible” behind Bernanke expressing concerns about the dollar as the Fed has pledged to keep interest rates low for an extended period.
To be sure, the dollar still has room to fall. Despite its losses so far, the greenback remains 7.5 percent above its record low against the euro at $1.6040 set in July, 2008. Speculative positioning data also shows that dollar shorts are not at extreme levels, and more good economic news could hasten more bets against the greenback.
In the near-term, the currency market will likely continue to trade off stocks, analysts say. The 25-day correlation coefficient between the S&P 500 index and euro/dollar is 0.77, Reuters data show, although that relationship has weakened slightly since October.
Ashraf Laidi, chief market analyst at CMC Markets in London, said dollar weakness has increasingly become a catalyst for U.S. equity rallies, which look unsustainable given mixed economic news and the recent struggle in oil prices.
“Aside from U.S. dollar weakness, we have yet to see any fundamental dynamic that justifies U.S. indices higher.” If stocks begin to retreat, the dollar could stabilize, he said.
The downside risks in euro/dollar are growing. Marc Chandler, global head of currency strategy at Brown Brothers Harriman in New York, said investors are paying “among the largest premiums of the year” for euro puts -- the right but not the obligation to sell euros -- over calls.
Some valuation measures also indicate the dollar is becoming undervalued. Morgan Stanley said the euro/dollar is now 27 percent too high compared with its median fair value.
Additional reporting by Nick Olivari; Editing by Dan Grebler