USD rebound: a temporary correction or the start of a new trend?

The US dollar has appreciated recently across the board, despite sellers making new highs. The AUD/USD, for example, one of the strongest pairs last year and so far this year, has fallen by more than three significant figures, from 0.88 to 0.7620 in just a few days. The EUR/USD did the same, and most forex dashboards showed a similar price development.

One explanation for the greenback's strength came from rising yields in the US. When long-term yields rise, investors rush out of equities, which has triggered a rise in the dollar. At least that was the initial thought when the Nasdaq 100 index fell from its highs on two consecutive days a week ago; this triggered a move down in the EUR/USD from 1.2240 and the AUD/USD from 0.80. In just a few days, the US dollar has taken a hit across the board.

However, stocks have rebounded. Meanwhile, the Dow Jones has hit two consecutive all-time highs, and Tuesday's Nasdaq rally is sweet revenge for the bulls trapped at previous highs. Yet the dollar has not given up its gains. It barely corrected, signaling a further decoupling of market functioning.

Speculative short positions in the dollar have hit extreme levels this year

At the end of last year and the beginning of 2021, short exposure to the US dollar reached extreme levels. Everyone was short the US dollar, as the huge market consensus of December revealed. It is therefore not surprising that short-term exposure exceeded two standard deviations from neutral, triggering strong rebound signals.

The last time the US dollar was sold so aggressively, the dollar index rebounded dramatically. Will the current move mark a similar reaction?

What about the recent $1.85 trillion fiscal stimulus that is about to be rolled out to the US economy? It should trigger another sharp decline in the dollar, at least according to conventional wisdom.

However, last Friday's employment figures present a different perspective. With vaccines in place, hospitalisations down, rates up and unemployment down, it's hard to argue for a dollar decline. Not to mention inflation - core inflation is still at a comfortable level.

Later today, core CPI (i.e. core inflation) is expected to come in at 0.2% on a monthly basis. This may be the data we need to know whether the recent trend in the dollar is the start of a bigger move or just a correction.