Analysis-US dollar may be due for a reprieve after a four-month decline

Factors Influencing the Dollar's Potential Rebound

By Laura Matthews

Market Sentiment and Positioning

NEW YORK, Feb 17 (Reuters) - The U.S. dollar is due for a bit of reprieve after its four-month decline as the political and economic backdrop turns in its favor and some market analysts turn bullish on the currency.

Analysts' Perspectives on Dollar Strength

The pressure on the U.S. currency from a range of factors such as the euro's rally, expectations for Federal Reserve interest rate cuts and the uncertainty caused by President Donald Trump's trade and fiscal policies has relented for now, analysts said.

Impact of Political Landscape

Meanwhile, improvement in U.S. growth prospects and business confidence, the sustained foreign investor bid for U.S. stocks and bonds and expectations Trump will be less aggressive heading into midterm elections this year are becoming a dollar tailwind.

The dollar index, which measures its value against currencies of six of its trading partners, has stayed below 100 since November, has fallen 6.7% since Liberation Day, and slid to a four-year low in January. The dollar's biggest losses have been against the high-yielding Australian dollar this year, but it has fallen even against the otherwise weak Japanese yen.

A dollar reversal could ripple through global markets, affecting trade flows, corporate earnings for multinationals and investment strategies for trillions of dollars in cross-border capital. After months of losses, a turnaround would also ease pressure on emerging market currencies and shift hedging calculations for investors worldwide.

"We are dollar bulls in a world of dollar bears right now," said Dan Tobon, head of G10 FX strategy at Citi in New York. 

Tobon sees the dollar strengthening up to at least the third quarter of this year, mostly against the euro, Canadian dollar and sterling, even if it is weighed down by factors such as the hedging of dollar exposures by foreign investors and the threat to Fed independence from the Trump administration.

A more growth‑focused and less politically volatile Trump administration ahead of the midterms will be added support, Tobon said. 

"We think animal spirits will be coming back a bit. All of these things in conjunction, in our view, should actually be quite positive for the dollar."

Jane Foley, head of currency strategy at Rabobank in London, believes much of the negative sentiment is already priced into the dollar, and the relative strength of the U.S. consumer is drawing investments into the country. 

POSITIONING FOR A RALLY

The dollar's slide has impacted global trade flows, corporate earnings for multinationals, emerging market currencies, and investment strategies for trillions of dollars in cross-border capital. Investors increased their ratio of hedges last year, their trades becoming another cause of the dollar's decline.

Now, derivatives positioning shows a slow turn in sentiment.

Currency options data in January showed traders were buying hedges to protect from further falls in the dollar, and were bullish on the euro, according to data from the CME Group.   

But the data shows hedging has abated since Kevin Warsh's nomination to lead the U.S. Federal Reserve, with risk reversals that measure skews in currency options in euro and sterling coming off January peaks.

Analysts say Warsh's reputation as a steady hand who doesn't favor having the Fed buy more market assets has soothed concerns over excessive Fed easing and any loss of its independence.

Warsh's nomination mitigates one aggravating factor behind the recent dollar slide, but is only a part of the reason, said Garrett DeSimone, head of quantitative research at OptionMetrics.

OptionMetrics data showed rising interest in structures known as butterflies, which bet on underlying currency pairs staying relatively steady. 

"Taken together, this suggests the market is dialing back bets on U.S. dollar debasement, while investors are still paying for convexity in either direction," DeSimone said.

NOT EVERYONE IS CONVINCED

Analysts at J.P.Morgan and BofA aren't that convinced the dollar can strengthen much.

Neither is Francesca Fornasari, head of currency at Insight Investment, who said perceptions of how the U.S. administration views currencies have changed in the past few days.

"We are in an environment in which the administration would like to have a weaker dollar," said Fornasari. "We think that the dollar is going to continue to grind lower over the course of the year."

(Reporting by Laura Matthews in New York; Additional reporting by Saqib Iqbal AhmedEditing by Vidya Ranganathan and Nick Zieminski)