Contrarian's Delight: A Dollar Rally

In the "catch a falling knife/step in front of a moving train" category, consider a bullish bet on the dollar after its latest schmeissing.

As a longtime, long-term dollar bear, I'm keenly aware of secular forces weighing on the currency, namely the widening U.S. current account and budget deficits (aka "the twins").

With the caveat that the long-term fundamentals point toward continued weakness in the dollar -- barring an abrupt about-face by U.S. policymakers -- there's good potential for a countercyclical move in the coming weeks.

"We're really in the midst of a one-way market and one-way markets don't last indefinitely," said David Gilmore, partner at Foreign Exchange Analytics in Essex, Conn. "I'm sure everyone has told you convincingly why the dollar will weaken ... and when 'everyone' says the same thing, usually the opposite occurs."

Certainly, the "sell the dollar" bandwagon has gotten very crowded. According to Bloomberg, currency traders and strategists are "more bearish on the dollar than at any time in the past 18 months."

Meanwhile, the financial press has jumped on board with hair-raising stories about the dollar's demise -- arguably a good contrarian indicator.

As of last Friday, futures traders had the highest net number of bearish bets on the dollar vs. the yen since February, according to the Commodity Futures Trading Commission. Notably, the Dollar Index, which measures the greenback's value vs. a basket of major currencies, hit a near-term low in mid-February and then embarked on a three-month rally.

No European Vacation

On Wednesday, the Dollar Index traded at its lowest level since August 1995 as the euro hit its seventh record high of the month at $1.3178 and the greenback slid to a new 4 1/2-year low vs. the yen and a nine-year low vs. the Swiss franc.

Falling Toward Recovery The beleaguered dollar nears potential support

Click here for larger image.

Source: Foreign Exchange Analytics

As illustrated above, the Dollar Index is at technical support at a trend line connecting to its January and February lows. "These patterns are considered to be bottoming/reversal patterns suggesting an upside resolution," wrote David Solin, partner at Foreign Exchange Analytics. "When the reversal higher does come, it is likely to be initially sharp and then settle into a month or so of wide-ranging [trading]."