The dollar's sharp seven-week drop is nearing a bottom, with technical charts pointing to oversold conditions and setting the tone for a short-term corrective bounce against the euro.
But investor concerns over the housing market slump's impact on the broader U.S. economy and possible further Federal Reserve interest rate cuts could prove an obstacle to the greenback's recovery, analysts said.
"We have come a long way in a short space of time. There is a good chance (the euro) could go back towards $1.3850. It's possible it could be more," said Tom Fitzpatrick, global head of currency strategy at Citigroup in New York.
The euro scaled a lifetime peak of $1.4281 this week and was last trading around $1.4135. The dollar has been on the ropes since mid-August when problems in the credit markets started to surface.
The turbulence stemming from U.S. home loans to people with poor credit histories, which were packaged and sold to investors around the globe, has caused liquidity problems and contributed to the Fed's decision to slash its benchmark overnight lending rate target by half a percentage point last month.
That step left investors anticipating further monetary easing at the Fed's remaining meetings this year and prompted them to dump dollar-demoninated assets in favour of the euro and other high-yielding currencies.
"In terms of psychology, we finished the quarter with a lot of people very bearish on the dollar. That reminds us a little bit of the excessive bearish sentiment we had at the end of 2004 and the first couple of weeks of 2005," Fitzpatrick said in a telephone interview.
"We saw quite a significant correction in favor of the dollar. There is a little danger that people are likely to be caught a little short dollars. You don't keep going forever in a straight line, even a good trend has corrections," he said.
DOLLAR'S DECLINE IN FINAL STAGES
Other analysts agree and suggest that the correction phase may last through this quarter, provided economic data does not come in worse than already expected. The euro appreciated 5 percent against the dollar in the third quarter.
"The mid-August decline in the dollar is probably in its final stages and unlikely to move appreciably lower without at least a multiweek corrective rally first. The (euro) decline I am looking for should at least take us back to $1.3850," John Kosar, head of research at Asbury Research in Chicago, said by phone.
"This little counter-trend move that we are expecting could dominate a lot of Q4. So, even if we start to trend upwards again in the euro and down on the dollar, I don't see it as higher than we are now, we might be a little lower," Kosar said.
The analysts are not alone in their views for a short-term fall in the euro. UBS, the No. 2 currency trader, predicts the dollar could trade at $1.38 in one month and as high as $1.35 in three months.
While the market has priced in further Fed rate cuts based on expectations of weaker economic data, Friday's non-farm payrolls report could upset this view, if it comes in worse than expected, analysts said.
The Labor Department data is expected to show that 100,000 non-farm payroll jobs were created in September after shedding 4,000 jobs in August, the first contraction in four years, according to a Reuters poll.
"The dollar is long overdue for correction. Having said that, if Friday's non-farm payrolls number comes out worse than expected, then we are going to see the dollar easily test its recent lows and new lows against the euro," said Omer Esiner, senior market analyst at Ruesch International in Washington.
"The key psychological level will be $1.43, that could be within target if we see disappointing non-farm payrolls on Friday," Esiner said by phone.
One other factor that could aid the dollar's chances of recovering is the G7 meeting later this month, amid a rise in rhetoric from some European leaders on the impact of the strong euro on the competitiveness of exports from the monetary area.
(Reuters)