×

Is the dollar poised for a sharp correction?

The U.S. dollar soared against the euro and the yen on Friday after the latest data showed the U.S. labor market was in robust health, but some currency analysts are eyeing a short-term pullback in the greenback, which could squeeze traders out of what is now a very crowded trade.

The dollar gained over 1 percent against the yen, while the euro weakened to trade at $1.1327 after nonfarm payroll data beat estimates on Friday, reversing recent dollar moves lower.

Andrew Harrer | Bloomberg | Getty Images

But after some softer productivity and trade data in the U.S. over recent weeks and small hints of improvement in the euro zone, some analysts are now suggesting investors position themselves for a short-term correction, which could temporarily interrupt the eight-month dollar rally.

"The U.S. dollar rally from the May 2014 lows has extended to achieve gains of over 20 percent, representing the most significant dollar rally since the 2008/2009 rebound," said Hans Redeker, head of global foreign exchange strategy at Morgan Stanley.

Read MoreWill a Strong US Dollar Scare Away International Tourists?

"U.S data has been somewhat soft recently, while there are signs of reflation and green shoots in Europe. This differential could drive investors to take profit on some of their long USD holdings. Given stretched positioning, this should drive a tactical U.S. dollar selloff. However, we believe

U.S. dollar weakness will be short-lived, and followed by a resumption of the bull cycle," he said.

Morgan Stanley have cut their U.S. dollar long exposure temporarily as a result of the potential for the correction and awaiting more "advantageous levels and conditions to reinstate medium-to longer-term bullish strategies."

"The dollar bull run could take a pause for breath and the danger now is that a broader correction could ensue squeezing what is a very crowded trade," senior analyst at currency broker FxPro, Angus Campbell.

Read MoreMarkets hit as ECB plays hardball with Greece

However, if European political tensions escalate and debt negotiations between Greece and its euro zone partners deteriorate from here, this could derail any short-term dollar weakness, Redeker said.

Nonfarm payroll data for January released on Friday showed employers hired steadily and wage growth picked up, with 257,000 jobs added in January beating consensus estimates of around 230,000 jobs.

But on Thursday, data revealed weakened productivity growth in the U.S. and a wider-than-expected trade deficit, which could result in a notable downward revision to real GDP growth in the last quarter of 2014.

"The U.S. dollar has continued to correct modestly lower in the Asian trading session giving back some of its strong gains from last month. This reversal in the U.S. dollar has coincided with a rebound in the price of crude oil, and recent evidence that the U.S. economy has lost some upward momentum," said Lee Hardman, a foreign-exchange strategist at Bank of Tokyo-Mitsubishi UFJ.