The dollar is cheap but is likely to remain weak according to David Bloom, the global head of foreign exchange strategy at HSBC in London.
"While we had been looking for the dollar to weaken in 2011, the fall has been more rapid and larger than we had expected," said Bloom in a research note.
With fears over the state of US finances pushing investors towards the euro despite its well documented debt crisis, Bloom said the dollar is now facing renewed questions about its role as the world’s main reserve currency status.
"At the same time, the US economic data has been soft enough to keep interest rate expectations in check, but not weak enough to increase concerns about the sustainability of the recovery," said Bloom.
"There is no doubt that the dollar is 'cheap' based in its real effective exchange rate and relative to PPP," he said. "Last week’s oil price collapsecould, perhaps, be enough to trigger position liquidation that would see the dollar enjoy a short term recovery. The euro has already given up ground on delayed tightening expectations and renewed concerns over Greece."
Will the Dollar Rally?
For the greenback to rally substantially, Bloom believes there needs to be a change in perception over US monetary and fiscal policy.
"The end to QE2 (the second round of quantitative easing) in June still has the potential to alter perceptions of monetary policy, but significant changes in fiscal policy look difficult to achieve ahead of next year’s elections," he said.
"The conclusion has to be that the dollar is unlikely to see more than short term rallies based on position liquidation and that it is likely to remain fundamentally weak for a further protracted period," said Bloom.