Battered Dollar’s Decline May Be Starting to Reverse

For the better part of the past decade, and particularly in the past few months, the U.S. dollar has been the weakling of the foreign exchange world. It lost value not just against almost every other global currency, including the euro, pound and yen, but even against the Romanian new leu and the Latvian lats.

Fueled largely by the Federal Reserve’s policy of printing dollars to help spur a healthy economic recovery that remains stubbornly elusive, the dollar earlier this month fell close to a 40-year low against a basket of other currencies.

Now, however, betting against the dollar may no longer be such a safe strategy — not necessarily because of any sudden macroeconomic shifts but because of a sense that the dollar sell-off may have finally gone too far. Since May 4, the U.S. currency has risen 4 percent against the euro and 2 percent against the pound, and has rallied against the Romanian and Latvian currencies as well.

The dollar’s bounce, while too brief to constitute a trend, has not been driven by any noticeable improvement in the economic fundamentals of the United States. Indeed, the faint but nonetheless real risk that Congress will fail to reach agreement on raising the legal ceiling on U.S. government borrowing only underscores the still parlous state of the U.S. economy.

At the same time, U.S. unemployment remains stubbornly high, at 9 percent, and there is a strong belief among big money investors that the Obama administration, as well as the Federal Reserve chairman, Ben S. Bernanke, tacitly welcome a cheaper dollar to spur exports and encourage U.S. manufacturers to hire more aggressively.

“The U.S. economy is still facing headwinds — from weak housing to reductions in government spending,” said Ray Attrill, a currency strategist for BNP Paribas in New York. “For those reasons we think the export sector is where policy makers are looking for growth.”

But analysts also see another, more technical reason behind the dollar’s decline — a decline that may well be ending. Ever since the global financial crisis began to ease in 2009, the appeal of investing in higher-yielding currencies and commodities all over the world has created what, in trader parlance, is called a risk-on, risk-off dynamic.

Investors tend to sell their safer holdings, like Treasury bonds, when they feel more bullish. Since 90 percent of the world’s hedge funds are based in dollars, those changes in sentiment can have a depressing effect on the U.S. currency. Reserve-rich central banks in emerging markets have also been selling dollars and buying euros to rebalance their reserve portfolios, said Mr. Attrill, citing recent data from the International Monetary Fund.

“Everything has been strengthening against the dollar — this is something that has not happened in the past,” said Stephen L. Jen, an independent currency strategist and former economist for the International Monetary Fund.

But that momentum now appears to have swung too far to one side — particularly as Europe’s own debt problems return to the limelight. Mr. Jen sees the rise of the euro, from $1.19 to a high of $1.49 over the past year, as overdone, especially amid festering problems in Greece and other weak euro zone economies. The euro is already back down to $1.42.

“With its sovereign debt issue and the growth differential in the euro zone,” Mr. Jen said, the euro is “just too expensive.” Other analysts have begun to say enough already, too.

In part, that is because much of the recent weakness in the dollar was driven by the perception that the European Central Bank, and to a lesser extent, the Bank of England, were more likely to raise interest rates to keep inflation under control than was the Federal Reserve, which remains committed to keeping short-term interest rates near zero. With rates likely to be higher in Europe than in the United States, traders moved their money out of U.S. government bills and bonds to gain greater returns abroad.

But the stronger the euro got, the more likely it became that its rise would begin to bite. As the euro rose to nearly $1.50, the strength of the currency started to raise doubts about whether the mighty German export machine, which gained competitive strength when the euro was weaker, could continue to perform so successfully around the world.

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