Is Artificial Strength of U.S. Dollar Coming to an End?

The unusual circumstances surrounding the underpinning of the U.S. dollar has many analysts unsure of how long that shifting foundation can last.

Forced liquidation or deleveraging has been the key reason the dollar has performed so well lately, and it's now questionable how much longer that process will remain a factor.

Once that slows down, the dollar will have tremendous downward pressure on it. Think of how that will sit with American businesses already facing major challenges from China and its currency.

Bob Sinche, head of global FX and rate strategy at The Bank of America in New York said, "Foundations for the dollar's recent rally have not been solid. The result of repatriation, deleveraging, quantitative easing and a major scarcity of dollars. But now we are bound for a correction."

It's not a matter of if, it's only a matter of when. And that seems to be coming on us pretty fast.

Another factor recently introduced is the steep and fast cuts coming from across the ocean in interest rates. That should also have some impact on weakening the dollar.

Most arguments aren't for some type of long-term wait for the downturn in the dollar. It could start any time, and could be at most, several months out. I haven't heard much about anything longer than that.

Some do think if it takes several months to happen, investors will be willing to take on more risk as economic conditions settle down - assuming they do - and other currencies may not be as attractive at that time.

One thing is for sure, the forced liquidation can't go on forever, and that will definitely undercut the strength of the dollar and put downward pressure on it.

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Deleveraging Continues to Push U.S. Dollar Upward

As major funds continue to deleverage in order to access cash, the U.S. dollar continues to be a major beneficiary, as the greenback continues to strengthen against major currencies.

Deleveraging means when funds and investors have to sell, they are buying back the U.S. dollar the had previously sold. That drives up the value of the dollar.

With no way of knowing how long companies, investors and funds will have to do this, the length of the time the U.S. dollar will remain strong will also remain unknown.

The U.S. dollar rose against the euro, British pound and yen during the trading session.

Within the dollar index (DXY), it increased to 86.35, a gain of 1.3 percent from the 85.834 close on Friday. The dollar index measures the U.S. dollar against six currencies.

How Long Will the U.S. Dollar Continue to Rise?

... At least as long as it takes for investors to unwind their positions.

The major reason behind the strengthening of the U.S. dollar is the money investors borrowed over the last several years that is now being called in by lenders.

With the vast majority of that debt being dollar-denominated, it has forced investors to do whatever they can to find greenbacks to pay off those loans. That, of course, has pushed up the value of the dollar.

The majority of this is happening because of the positions held by institutional investors.

Even though this is all true, the tremendous upward movement of the dollar is due for a correction, and I would think it will have to happen sometime soon.

In reality, the dollar really isn't stronger than other currencies, as explained, but it is the currency used in most transactions that have to be unwound. Once that period of time is over, we'll see tremendous downward pressure on the dollar as inflationary pressures once again dominate the currency.

Still, the dollar is expected to continue rising, even though it will experience temporary breathers and drop over a few sessions during this time of unwinding.

What is "Forced Liquidation" or Deleveraging?

We're hearing a lot about forced liquidations and deleveraging lately, and their effect upon the U.S. dollar and gold, among most commodities.

What it basically means is someone borrowed money to make a trade. When the money is no longer available to borrow to keep the trades going, investors are forced to sell their investments in order to pay back those loans.

This is why even though the underlying fundamentals that would normally result in a weaker U.S. dollar and surging gold price are still there, they haven't performed in their normal manner.

A number of commodities are being hammered for this very reason; especially gold.

The reason this happens is institutional investors that need cash are "forced" to sell positions in commodities they would rather keep, driving the price down. That's the reason it's called forced liquidation or deleveraging.

Because we are in an unusual situation, it's difficult to know or project the timing of when this will all revert back to normal.

We can be sure of one thing: it will eventually even out and the U.S. dollar will fall, while the price of gold will surge. It's a matter of when, not if.

U.S. Dollar Continues as Safe-Haven Choice

With many gold funds needing cash, along with ongoing deleveraging, the U.S. dollar continues to be the refuge of choice for many jittery investors.

With the dollar and the yen basically mirroring the movement of the equities market, they have been the cheif beneficiaries of current market conditions.

The yen is still playing its customary role of measuring risk, and the dollar is moving pretty closely in step, playing a similar role as well.

For the yen, when stocks strengthen - investors sell, when stocks plummet, they're quickly buying the Japanese currency.

The yen continues to be pressured because risk-adverse investors are abandoning carry trades at this time; that has helped the U.S. dollar hold its strength. It'll continue to be difficult to guage risk while the market seesaws back and forth.

Those currencies which will be most negatively impacted by the continuing strength of the dollar will be the British pound and euro.