The dollar is nearing its highest level of the year amid problems in Europe. What do analysts recommend?

The dollar has approached its high for the year amid fiscal challenges and growing political uncertainty in Europe, which have boosted its appeal as a safe-haven asset, according to Bloomberg. At the same time, the currency’s continuous rise is fueling concerns that the rally is becoming excessive, the agency notes.

The Bloomberg Dollar Spot Index rose 0.4% on October 5 amid a weakening euro. The index has been rising for more than three consecutive weeks. It has reached overbought levels according to several indicators, which means a reversal could begin soon, Bloomberg warned.

A series of key U.S. macroeconomic data releases could determine how long the dollar’s rally lasts: this week will see the release of the services sector PMI, labor market data, and the University of Michigan’s consumer confidence index. The focus will be on signals regarding the Federal Reserve’s next interest rate decision, Bloomberg noted. Investors will also be able to review the minutes from the Fed’s September meeting, when the rate was raised for the first time in three years.

The European currency fell to a 17-year low during trading on October 5 following the announcement of early elections in Spain and amid ongoing investor concerns about France’s debt and the country’s upcoming presidential election. Although currency market analysts predict further weakness for the euro, many acknowledge that the recent sell-off is linked to tensions in the European bond market and could subside if the situation eases, according to Bloomberg.

In addition, the agency notes that the decline of the single European currency against the dollar has been relatively modest compared to the drop in the Swiss franc and the Norwegian krone. This indicates that investors are willing to seek alternatives to the U.S. dollar when establishing “bearish” positions.

“The overbought and overvalued dollar may prove vulnerable to any negative surprises from U.S. economic data this week, especially if it causes investors to reassess the sustainability of the ‘hawkish’ consensus within the FOMC (Federal Open Market Committee of the U.S. Federal Reserve — Oninvest),” said Valentin Marinov, head of research and strategy for G10 currency markets at Credit Agricole. One of the bank’s models currently recommends opening long positions in the British pound and the Swedish krona against the U.S. dollar.

Analysts also warn that renewed concerns about the state of Washington's own public finances could knock the U.S. currency off its recent highs.

The dollar's latest rally has also prompted caution among analysts at Morgan Stanley, who recently adopted a "bullish" stance on the U.S. currency.

“We fear that a sudden increase in the risk premium—which is negative for the dollar—could lead to a ‘stop-out’ (forced liquidation. — Oninvest) of long positions in the U.S. currency. As a result, we would prefer to buy on dips rather than buy at current levels,” say Morgan Stanley’s currency market strategists, led by David Adams.

This article was AI-translated and verified by a human editor