An overbought dollar lurches even higher

The dollar has gained about 12 percent against the euro since the year began. It is on track for its best month versus the single currency since its launch in 1999.

The greenback has also surged against high yielders such as the Australian and New Zealand dollars, rising roughly 25 percent. It has punished emerging market currencies as well, once the darlings of the investing world because of their current account surpluses and competitive interest yields.

It’s less about the United States and the dollar being a safe haven, some analysts say. After all, the storm started in this port, starting with the subprime credit crisis that erupted in the summer of 2007 as U.S. house prices fell.

Global deleveraging has been the culprit. Investors had used borrowed funds to increase their portfolio bets in recent years. These borrowings are now being called in by lenders and if the debt was priced in the U.S. currency — and most of them were — the result is a short squeeze, a scramble to find dollars to repay those loans.

"Foreign-exchange movements reflect major unwinding of positions and the need to cover losses on other dollar assets," said Avery Shenfeld, senior economist at CIBC World Markets in Toronto.

"The dollar could become significantly overvalued during this turmoil and there is nothing that could prevent the U.S. dollar from getting to $1.20 against the euro," he added.


Still, technical indicators are suggesting that the U.S. dollar’s blistering rally may have to take a breather soon, given how far it has advanced over the last three months.

According to the charts, the euro has been oversold across short and longer time frames. A technically overbought dollar tilts toward even more overbought territory.

"This is a dangerous game at the moment for a technical trader who may rely on oscillators, so be careful out there and keep your stops tight," said Jack Crooks, president of currency investment adviser Black Swan Capital in Palm City, Florida.

Crooks noted, however, that the dollar index is also at a level "where we just might get what we refer to as major capitulation to the trend by the perma bears."

He sees resistance at 87.30 in the dollar index. On Thursday, the ICE Futures dollar index was at 85.231 .DXY just before 4 p.m. in New York, after hitting a fresh two-year high at 86.120.


One of the most bearish forecasts on the euro came from BNP Paribas, which predicted a print of $1.13 by the first quarter of 2010. On Thursday, it traded below $1.28.

The euro has fallen more than 20 percent against the dollar since the single currency hit a record high above $1.60 in mid-July.

And it’s easy to see why.

In the past month, several European banks had to be bailed out, emphasizing the global nature of the credit crisis.

Economists also believe that unprecedented efforts by central banks and governments to shore up the global financial system, including some of Europe’s biggest houses, will not be enough to prevent the euro zone from sliding into recession.

"The weakening of the European economy and by extension, the eastern and central European bloc has weighed on the euro. It’s not looking very good at the moment," said Sebastien Galy, a currency strategist at BNP Paribas in New York.

He added that there’s little hope for an inspired bailout for countries in central and eastern Europe, which have come under pressure as funds flow out of their markets.

Moreover, Galy said the European Monetary Union’s budget has already been stretched to its limits. He also cited political opposition for creating a bailout program supported by public funds.

"The descent of the euro has been faster than we initially thought. We expect a further undershoot in the euro at least until the summit in mid-November," Galy said, referring to the conference organized by the White House to be held next month in Washington. The summit aims to further address the global financial crisis.

Yet despite heavy bets favoring the dollar, some analysts say the buck could use a breather and fall back for a few days.

"Even though we expect the dollar to climb plenty higher, we’re at a point where a corrective move may be long overdue," said Black Swan’s Crooks.