Analysis-Dollar gains from rivals' trouble may lack staying power

By Saqib Iqbal Ahmed and Laura Matthews

NEW YORK (Reuters) -A rebound in the dollar over the past month is unlikely to last given it was largely due to repositioning over temporary factors including the disruption of U.S. economic data due to the U.S. government shutdown and upheaval in the governments of rival currencies.

The greenback has climbed about 3% against a basket of currencies since mid-September, recovering from more than three-year lows after falling nearly 11% earlier this year.

Speculators' net short bets on the dollar fell to $9.86 billion from a two-year high of $20.96 billion during that period, CFTC data showed before the U.S. government shutdown disrupted releases.

Options markets also show the turn in sentiment in favor of the dollar with one- and three-month EUR/USD risk reversals recently hitting their most euro bearish levels since mid-June.

Still, analysts are broadly skeptical of the dollar's recovery. 

"In the three- to six-month view, I think the dollar is going to be falling because I think the U.S. economy is going to weaken and the interest rates are going to come down," said Marc Chandler, chief market strategist at Bannockburn Capital Markets.

Much of the dollar's recent rebound can be attributed to investors covering bearish bets on the currency.

"What's going on in markets is basically a positioning adjustment," said Jayati Bharadwaj, a global FX strategist at TD Securities.

Indeed, some analysts said the dollar rally may be running out of steam.

"We've definitely seen a very nice period of dollar strength," said Joel Kruger, market strategist at London-based LMAX Group, which operates multiple global institutional FX exchanges.

Kruger sees risks for further dollar weakness in the near term.

INTERNATIONAL DEVELOPMENTS BOOST DOLLAR

The dollar sold off in the first half of the year on worries over fading U.S. exceptionalism, concerns about a hit to economic growth from President Donald Trump's protectionist trade stance, and the specter of a ballooning U.S. budget and international trade deficits.

But given the interruption of U.S. economic releases and political crises outside the United States — in Japan and France — investor attention has swung away from the dollar's travails.

The euro snapped a two-month winning streak to trade down about 1.3% for October, while the yen has slipped nearly 3% against the rising greenback.

Chaos and uncertainty in France, the euro zone's second-largest economy, have caused the euro to weaken against the greenback, while political shifts in Japan have swayed investor expectations for the Bank of Japan's monetary and fiscal policy, piling pressure on the yen.

But investor reaction to recent international developments may have gone too far, analysts said.

"The surprising outcome of the LDP (Liberal Democratic Party) leadership election led to significant JPY weakness as investors increasingly position for fiscal expansion and a dovish BoJ," Morgan Stanley strategists said in a note on Friday.

"We think such positioning is excessive," the strategists wrote.

COUNTER-TREND RALLY

An early October Reuters poll of FX strategists showed the dollar weakening against all major currencies over the next three, six and 12 months, against the backdrop of rising U.S. fiscal deficit and worries that the Federal Reserve's independence may come under threat.

"The dollar will weaken through time, but there are always these counter trend rallies," Colin Graham, head of multi-asset strategies at Robeco in London, said.

"So we're playing dollar from the short side, but we are actively managing how big that position is," Graham said. 

SHUTDOWN END AS A CATALYST?

That said, should U.S. economic growth surprise to the upside and the Fed end up not meeting expectations for rate cuts in coming months, it may help the dollar extend its rally, analysts said.

For now, many of the catalysts that drove the dollar's drop this year, including worries about U.S. growth and the outlook for monetary policy, remain in place even though recent developments may have put them on the back burner.

"U.S. economic data after the U.S. government reopens could become the catalyst to change this weaker yen trend," Morgan Stanley strategists said, recommending investors stay short the dollar against the yen.

With Fed Chair Jerome Powell in the final months of his current term and the Trump administration's ongoing efforts to oust Fed Governor Lisa Cook from the central bank, questions about the Fed's independence and confidence in the dollar are also likely to gain importance in investors' minds.

"Investors remain worried about Fed independence and the potential impact on USD. But for now they are focused on other issues," BofA Global Research analysts said in a note on Friday.

Meanwhile, the long-awaited resumption of the Fed's rate-cutting cycle is likely to cheapen hedging of dollar exposure for foreign investors, piling more pressure on the buck.

"I think that the dollar's big dollar super cycle has ended, and we're in the down part of it," Bannockburn Forex's Chandler said.

(Reporting by Saqib Iqbal Ahmed and Laura Matthews; Editing by Alden Bentley and Anna Driver)