When a country's economy gets stronger, its currency follows. The recent unemployment report on Dec. 4 was much better than expected. If the economy is stronger, the Federal Reserve will raise interest rates. Both of these factors have sparked a dollar rally.
The rally was most likely caused by short-covering, the Financial Times reports. When a trader "sells short," he or she must "buy" to cover the position. The Chicago Mercantile Exchange (CME), where currency contracts are traded, keeps a running tally of the long and short positions in each currency. On Dec. 1, there were 172,367 net short dollar positions. By Dec. 8, this number had dropped to 107,284, The value of this shift in net positions was $9.8 billion dollars.
Summing up, Hans Redeker of BNP Paribas said: "The conclusion he drew from these events was not if to buy the dollar but when to move into big long positions."
Traders may wait until the new year and reassess their positions. Usually the weeks before year-end are used for position squaring, rather than adding new trades.
The Fed's policy statement this week will undoubtedly set the stage. If the Fed hints at raising rates, look for the dollar rally to continue. If it's the same old loose money policy, this brief dollar rally could fizzle out quickly.
Do you believe the Fed will keep its loose money policy?
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