Dollar May Weaken as Euro Draws Buyers

The U.S. dollar is likely to fall in the week ahead as investors continue to bet that interest rates in the euro zone will rise ahead of those in the world's largest economy.

U.S. February jobs data came in a touch better than expected on Friday but disappointed investors who had hoped for an even stronger report.

Investors see strong U.S. jobs growth as necessary for the Federal Reserve to end its second round of quantitative easing and instead tighten monetary policy by raising rates.

The U.S. situation is in sharp contrast with that of the euro zone, where the zone's common currency is likely to remain supported after European Central Bank President Jean-Claude Trichet strongly hinted at an interest rate rise in April, bolstering the view the ECB will tighten monetary policy before the Fed.

"We had Mr. Trichet warning Thursday that the ECB is considering a rate hike and perhaps the start of a rate hike cycle," said Joseph Trevisani, chief market analyst at FX Solutions in Saddle River, New Jersey. "The U.S. job number came in as expected and provided little direction to the market other than it did not disappoint and that will support risk appetite."

For the week, the euro gained 1.7 percent against the dollar on electronic trading platform EBS, the third straight weekly gain, while the dollar gained 0.8 percent against the yen.

A slew of technical factors also indicate investor caution on the dollar, particularly against the euro.

One-month euro/dollar risk reversals last traded at -1.175 on Friday, according to Reuters data, with a bias toward euro puts and dollar calls, suggesting more investors are betting the euro will fall than will rise.

But that compares with late November when one-month risk reversals posted at -2.83, suggesting negative sentiment on the euro has eased substantially. The euro has already gained more than 6 percent against the dollar since that time.

Those gains pushed the euro/dollar above its 200-week moving average this week for the first time since mid November, piercing a strong long-term resistance level.

There is now little to prevent the euro's rise to $1.4283 on EBS, the November high from which it slid to $1.2860 in January but from which low it has steadily retraced higher. Stamford, Connecticut-based Faros Trading sees the euro making a move to the $1.50 level within the next three months.

Nearer term, the buy signal triggered on Feb. 23 when the 12-day and 26-day moving average convergence divergence line rose above the 9-day signal line is also holding. The MACD is an indicator of short-term momentum by focusing on exponential moving averages and closing prices.

Investors were betting heavily against the dollar ahead of the jobs data and Trichet's comments.

The value of the dollar's net short position rose to $34.9 billion in the week ended March 1 from $22.36 billion a week earlier, according to Commodity Futures Trading Commission data on Friday and Reuters calculations. It was the largest net short dollar position for which Reuters has data, dating back to June 2008.

Net long positions in the euro rose to 51,308 contracts, the highest since January 2008, from 45,598 contracts in the prior week.

The dollar is also seen struggling against the yen as it failed to hold onto its initial gains after the jobs data.

"Bernanke may be relieved to see another month of improvement in the unemployment rate, but given the underlying weakness of the report, the central bank will still argue that unemployment remains extremely high and therefore continued stimulus could be warranted," said Kathy Lien, director of currency research at GFT in New York.

Bets on the yen also jumped to 41,274 contracts, only the largest since November but a big change from the 27,746 short bets last week.

With talk that the Fed may even go for a third round of quantitative easing after the current phase ends in June, strong jobs growth for at least the next three months is consequently key to any dollar revival.

Even ongoing political instability in the Middle East and North Africa and the threat that it may spread to Saudi Arabia, a key U.S. ally in the region and a global oil supplier, could weaken the dollar.

While the dollar has been regarded as a safe haven in times of turmoil, some investors suggest higher oil prices would push other central banks to raise interest rates to counter inflation even as the Fed maintains its stimulative monetary policy, which would again leave investors chasing yield with little choice but to sell the dollar.