Dollar Rally May Stall But Not For Long. By Nicholas Hastings

The dollar is probably now only at base camp. And its climb to the summit still has some way to go.

Over the last week or two, the U.S. currency's rally has certainly lost some of its momentum.

Extreme speculative positioning, hopes of a resolution to Greece's debt problems and even talk that China might finally allow some appreciation in the yuan have all helped to reduce investor interest in the greenback.

But this won't last.

In fact, it shouldn't be long before strong fundamentals reassert themselves and renewed expectations of a U.S. rate rise send the dollar higher again.

See how far the euro has already fallen against the dollar this year:

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This week, the Fed will have contributed to just such upward pressure with the news that it is widening the counterparties that participate in reverse repo operations as it takes another step in reducing market liquidity put in place because of the credit crunch.

As economists at The Royal Bank of Scotland Group PLC said, the Fed is "setting the table for an eventual tightening."

Some market analysts are now expecting the U.S. central bank to start hiking rates as early as June and betting how quickly the Fed will abandon its pledge to keep rates low "for an extended period."

All this is already reflected in money markets where U.S. yield spreads have risen, making the dollar that much more attractive given that rate hikes in other major economies from the euro zone, through the U.K. and Japan, are very much on hold.

In fact, monetary policies in these other economies may well have to be eased even further, given the recessionary risks that are still at large.

Although speculators may have pushed their long dollar positions up to extreme levels in recent weeks, that doesn't mean that they can't continue buying the dollar, especially given that the most recent data show signs of a small shakeout.

At the same time optimism that Greece's debt problems will go away is falling fast. Although Athens has got the backing from the European Union, the government still has to implement its austerity measures and prove that it can continue servicing its debt.

In the meantime, growth in the euro zone as a whole could suffer, ensuring that any early plans for an end to the euro zone's easy monetary policy are postponed.

Despite talk in Beijing that the country's currency peg against the dollar will come to an end, there is little sign that China is about to bow to external pressure and let the yuan appreciate anytime soon.

This means little export relief for Japan and another reason why investors, already worried about Japanese deflation, may start selling the yen again.

Early Wednesday in Europe, the dollar is mostly higher again as a drop in Germany's trade surplus and a decline in Japanese machinery orders knocked market sentiment once again.

The move back into safer haven currencies came despite news that Chinese exports soared by 45.7% last month, much more than the market anticipated. This will increase calls for Beijing to let its currency appreciate.

By 0745 GMT, the euro had fallen to $1.3568 from $1.3603 late on Tuesday in New York, according to EBS.

The euro was also down at Y122.13 from Y122.43 as the dollar traded fairly flat at Y90.00 from Y90.01.