Dollar to rally higher? The math doesn't add up

Published Wed, Mar 11 20158:44 AM EDT

Evelyn Cheng @in/evelyn-cheng-53b23624 @chengevelyn

Strategists see dollar bull continuing, but math suggests they could be wrong. The upward run in the U.S. dollar to nearly 12-year highs shows the currency index could be reaching a peak soon, if history is any guide. As of Tuesday's close, the dollar index was nearly 3 standard deviations above its 50-day moving average. Since 1986, the index has been in this position just 0.58 percent of all trading days, according to quantitative analysis tool Kensho. The probability of the index moving lower in the following days is 92.3 percent and the probability of the index moving higher is 7.7 percent. The decline in the euro after the beginning of quantitative easing on Monday in the euro zone is the major factor behind the dollar's surge. Source: FactSet With the euro representing nearly 60 percent of the dollar index, the U.S. dollar extended gains to advance nearly 1 percent on Wednesday as the euro fell below $1.06 for the first time in 12 years. Since the launch of the euro in January 1999, the European Union's currency traded below $1.07 for 939 days. Under those conditions, the dollar index had an average return of negative 0.4 percent, Kensho analysis showed. Read More Mighty dollar: Casualties rise in 'currency war' "Monetary policy in the euro zone will diverge sharply from the United States in 2015 and 2016, possibly sending the euro to parity against the U.S. dollar by year-end 2016," PNC Financial Services' Senior International Economist Bill Adams said in a note Monday. "The dollar will probably see some additional appreciation through the end of this year because of Fed tightening, (but) the rate seems likely to slow," Adams told CNBC. "The strength of the dollar is (based on) momentum and stark divergence between the U.S. and part of the world, but it won't last forever." Pressure from the strong dollar sent U.S. equities lower on Tuesday, with the major indexes down more than 1.5 percent. Investors also fretted over Friday's strong jobs report that indicated the Federal Reserve might raise interest rates sooner rather than later. But historical analysis by Kensho showed some profit taking after the Fed actually raises rates, with the dollar index falling an average of 1.8 percent three months after a rate increase.The study looked at 45 instances since 1987. While analysts from investment research firms such as Piper Jaffray and Raymond James still see a bullish case for the dollar, the skeptics have stepped up their hedging. "Our data suggests that sentiment is currently at bullish extremes that we have never seen before. Meanwhile, the 'smart money', commercial hedgers, are hedging at a rate that we have never seen before," said J.C. Parets, president of Eagle Bay Capital. "Commercials suggest euro goes higher and dollar lower based on their actions." Read More These stocks have gained 1,000%+ during bull run Strategists are also taking a position. David Woo, FX and rates strategist at Bank of America Merrill Lynch, wrote in a report Monday that while strong domestic data usually lead to higher U.S. bond yields and a stronger dollar, "we think the market is underpricing the risk that the positive correlation between US rates and the USD will turn negative on further USD strengthening." DISCLOSURE: CNBC's parent NBCUniversal is a minority investor in Kensho.

A trader works on the floor of the New York Stock Exchange.

Adam Jeffery | CNBC

Strategists see dollar bull continuing, but math suggests they could be wrong.

The upward run in the U.S. dollar to nearly 12-year highs shows the currency index could be reaching a peak soon, if history is any guide.

As of Tuesday's close, the dollar index was nearly 3 standard deviations above its 50-day moving average. Since 1986, the index has been in this position just 0.58 percent of all trading days, according to quantitative analysis tool Kensho. The probability of the index moving lower in the following days is 92.3 percent and the probability of the index moving higher is 7.7 percent.