Dollar Bears Under Pressure as Short Squeeze Continues

US dollar is on an upswing

In April, the US dollar index posted one of its best monthly gains (2.0%) since November 2016, and it looks set to continue with the trend this month. The main reason for this appreciation has been a higher positive correlation between the US dollar and bond yields. Rising bond yields increase the US-international bond spread, which increases preference for US bonds as they have better ratings. This higher demand for US bonds indirectly boosts demand for the US dollar (UUP), as these bonds are dollar denominated. Recent economic data and the Fed’s proposed rate hike path have also boosted the US dollar, leading to a short squeeze for dollar bears in recent weeks.

Dollar Bears Under Pressure as Short Squeeze Continues

Speculators feeling the short squeeze

According to the Commodity Futures Trading Commission’s May 1 Commitments of Traders report, large speculators and traders have trimmed their short positions on the US dollar index. Short contracts fell from 1,781 contracts to 1,734. According to Reuters calculations, net US dollar (USDU) short positions fell from $19.8 billion to $15.2 billion. This amount is a combination of the US dollar’s contracts against the euro’s (FXE), British pound’s (FXB), Japanese yen’s (FXY), Australian dollar’s (FXA), Canadian dollar’s (FXC), and Swiss franc’s combined contracts.

Key events for the US dollar this week

Currency markets could be dominated by US dollar demand going forward. The Fed’s rate hike path, the US dollar’s increased correlation with bond yields, and rising bond yields are the key factors driving US dollar demand. Concerns about escalating trade tensions and a steepening fiscal cliff are not likely to play a major role for the time being, as discussions are ongoing. US inflation and job openings data, scheduled to be reported this week, are expected to be upbeat, leaving little chance for the US dollar to slide. In the next part of this series, we’ll discuss why the euro could continue to fall.