DOLLAR DROP COULD WELL BE OVERDONE

OVER the past month euro-dollar has been in a near-vertical uptrend, rising more than 1,000 points in just 22 trading days. But now that the pair has reached the psychologically important 1.4000 level, it may be due for a pause as positioning becomes grossly overstretched. The reasons for dollar weakness are well known. The Fed’s open call for more QE has dominated trade in the currency markets for over a month. With most other G10 central banks talking about tightening or maintaining policy, the Fed’s insistence on printing more money has turned the greenback into persona non grata. The buck hit all time lows against the Aussie and the Swissie. The euro rose more than 10 per cent because it benefits from being the dollar’s only liquid alternative.

However, the anti-dollar rally may have run its course for now. The latest positioning data revealed that speculators increased their bets against the greenback by more than $30bn – the largest jump since 2008. Speculators were long 48,243 contracts of euros – their biggest position since October 2009. Last year, the euro-dollar peaked within two months of reaching such extreme positioning. While positioning is rarely a good predictor of long-term price action, extremes often lead to at least a temporary correction. With euro-dollar having rallied relentlessly for more than a month, some sort of pause may be due, especially if the market begins to question the scope of QE.

At present, traders have priced in $1 trillion of additional QE from the Fed. However, if the actual size is more modest, the dollar could rally on the classic “buy the rumour, sell the news” dynamic. Although yesterday's FOMC minutes revealed that there is consensus within the Fed for more QE, they also revealed a disagreement as to its magnitude. If US data begins to show even a mild improvement, euro-dollar could correct to $1.3750 to work off its overbought condition.

Boris Schlossberg and Kathy Lien are directors of currency research at GFT. Read commentary at www.GFTUK.com/commentary or e-mail borisandkathy@gftuk.com.