Original article by Adam Button, via ForexLive and TradingView
Title: Dollar Short Squeeze: Is There More Momentum to Come?
The US dollar has displayed surprising resilience in recent days, leading to speculation about whether its recent rally is the start of a broader reversal or simply a pause in an ongoing downtrend. The move caught many traders off guard, as bearish sentiment on the greenback had been the dominant theme in the weeks prior. The current market dynamic suggests the possibility of a short squeeze, where traders exiting bearish positions on the dollar may be fueling its rise. Let’s examine the current situation in detail and explore whether there is more room for the US dollar to extend its gains.
Short Squeeze Dynamics
A short squeeze occurs when traders who hold short positions (betting against an asset) are forced to cover their positions due to a sudden and unexpected rally in the asset’s price. In this case, the dollar’s recovery from oversold conditions appears to be causing such a reaction. Several factors are contributing to this situation:
– The market was heavily short the US dollar, with speculators betting on an extended decline due to falling inflation and expectations of Federal Reserve rate cuts.
– A slight shift in economic data or sentiment that supports the dollar can lead to a rapid unwind of these short positions.
– When traders begin to cover their shorts, it turns into buying pressure, accelerating the currency’s rebound.
Recent Dollar Moves
The dollar’s bounce has been especially pronounced in some key pairs. Among the most notable movements:
– EUR/USD, which had climbed toward 1.0900, pulled back and now trades closer to 1.0730.
– GBP/USD lost ground after touching 1.2850, now testing support near 1.2650.
– USD/JPY moved sharply higher, reclaiming levels above 146.00.
– Risk-sensitive currencies like AUD and NZD also saw declines versus the dollar.
This rebound has created discomfort for dollar bears as previous downtrends reversed quickly. Many traders are questioning whether they underestimated the dollar’s ability to retrace.
Traders Caught Offside
Several positioning indicators hint at crowded short trades in the dollar before the recent rally:
– CTA (commodity trading advisor) models had built significant short exposure to the USD.
– Real money accounts appeared to be selling dollars into strength, expecting follow-through downside.
– Retail traders had piled into bearish bets on pairs such as EUR/USD and GBP/USD.
As these positions unwound, technical levels were breached, adding to the momentum and creating a feedback loop of short covering.
Interest Rate Expectations and Economic Data
Part of the fundamental thesis for a weaker dollar had centered around the notion that the Fed would proceed with rate cuts amid slowing inflation and evidence of weakening demand. However, recent data has not completely aligned with that narrative:
– The US labor market remains resilient, with solid non-farm payroll numbers and low jobless claims.
– Inflation data, while easing, has not yet convincingly fallen to the Fed’s 2% target.
– Some Fed officials have pushed back on the idea of aggressive rate cuts, favoring a patient approach.
This pivot in expectations has helped support the dollar, especially as yields on US Treasuries remain elevated relative to other developed economies.
Global Central Bank Divergence
Differing policy paths across global central banks are shaping currency dynamics. Recent developments that have supported the US dollar relative to peers include:
– The European Central Bank (ECB) has hinted at an easing cycle starting soon, possibly as early as June.
– The Bank of England (BoE) has delivered a dovish tone, despite high UK inflation, suggesting it may also cut later this year.
– The Bank of Japan (BoJ) continues to maintain ultra-loose policy, widening policy divergence with the Fed.
When central banks outside the US pivot toward easing, while the Fed remains steady or slows its rate-cut path, it supports the dollar due to higher yield differentials.
Technical
Read more on EUR/USD trading.