The dollar rallied against a basket of rivals on Monday as a squeezing-out of crowded short positions combined with safe-haven demand gave the currency some respite after its weakest monthly performance in a decade.
The dollar index =USD, which measures the greenback against a basket of leading currencies, lost more than 4% in July, its biggest monthly drop since September 2010. It is down 10% from its peak in March. Graphic: Dollar's worst monthly performance in a decade - here
Analysts put the slide down to waning safe-haven appeal as financial markets recover, market expectations for further easing of US monetary policy, and a lack of agreement among US lawmakers on further fiscal stimulus. Falling US bond yields have also been cited as a factor.
"The factors that have seen DXY (the dollar index) fall 10% from its spike high in March are still in place and we expect a 'sell the rally' mentality to develop through August," ING strategists said in a note to clients.
Speculators' net shorts on the US dollar have soared to their highest since August 2011 at $24.27 billion, Reuters calculations and US Commodity Futures Trading Commission data show. [IMM/FX]
A partial squeezing out of that crowded short position may be the reason for the dollar's rally in the past couple of days, analysts said, also citing rising geopolitical tensions between the United States and China.
"There's usually something that trips global markets up in August, and this year might not be different given the growing list of market risks," said Viraj Patel, global FX and macro strategist at Arkera.
"Given the way that risky assets have rallied in recent months, this rising geopolitical threat could lead to a squaring off in positions and potential reversal of recent trends that would help the dollar recoup its recent losses."
The dollar index was up almost half a percent by midday in London =USD, with the greenback higher against all currencies in the basket on which the index is based. CHF= SEK= EUR= GBP= CAD=
Against the Japanese yen, the dollar gained 0.1% to push past the 106 yen per dollar mark. JPY=
On Friday, the dollar posted its biggest daily rise against the Japanese currency since March, halting a rally in the yen which saw it gain 3% in July.
Japanese Finance Minister Taro Aso described the yen's recent rise as "rapid" on Friday, signalling concern that a strong currency could do more damage to an export-led economy already in recession.
Investors have reasons to worry about the US outlook as policymakers struggle to clinch a deal to pump more money into the world's largest economy.
"We'll also be focusing on (the US) Congress, where the $600 per month unemployment benefit boost has now expired and the parties are wrangling over the design of the Phase IV stimulus package," ING said in a note.
"Delays here may upset asset markets, which typically tend to struggle a little more in August."
A growing US fiscal deficit to finance the stimulus prompted Fitch Ratings to revise its outlook on the United States' triple-A rating to negative from stable.
While there has been no immediate market reaction to the downgrade, the European Union gained a lift from Standard and Poor's decision to upgrade its rating outlook on the bloc to positive from stable.
Sentiment on the euro has improved after EU leaders agreed last month to a 750 billion euro ($882 billion) economic recovery fund while also taking on debt jointly in a show of regional cooperation.
The single currency traded at $1.1763 EUR=EBS in morning trade in London, off a two-year high of $1.1908 hit last week.