Dollar to rally as traders most bullish since 2003

The dollar, up 7.5 percent against the euro this year, will extend its rally as traders are their most bullish on the U.S. currency in more than 18 months, according to a Bloomberg survey.

"The three-year decline in the dollar is over," said Derek Halpenny, a currency strategist in London at the Bank of Tokyo Mitsubishi Ltd. "Momentum is with the dollar. We could see further gains." Halpenny said he may raise his dollar forecast.

Seventy-five percent of the 52 strategists, investors and traders polled on Friday from Sydney to New York said to buy the dollar against the euro, up from 55 percent in the prior week. The last time the survey was this bullish was in August 2003.

Deutsche Bank AG, JPMorgan Chase & Co. and Barclays Capital are among banks to boost their estimates for the dollar as the Federal Reserve raises interest rates, U.S. employers increase hiring and consumers step up spending. In Europe, Italy's economy is in recession and European Union finance ministers said on Friday they have "serious concerns" about growth.

The dollar traded at $1.2606 per euro at 11:05 a.m. in Tokyo, from $1.2634 late on Friday in New York, according to currency dealing system EBS. The U.S. currency, which climbed 1.4 percent last week, earlier rose to $1.2583, the strongest since Oct. 21. Against the yen, it was at 107.53 from 107.32, after gaining 2.2 percent last week, the biggest weekly gain since December. More survey participants recommended selling the yen than buying it.

Bank of Tokyo-Mitsubishi, a unit of Japan's second-largest lender, may raise its forecast for the dollar to $1.15 per euro by year-end, up from $1.20, said Halpenny. The dollar fell to a record $1.3666 versus the euro on Dec. 30.

"The dollar is undervalued," said former Fed Governor Lyle Gramley, now an economic adviser at the Stanford Washington Research Group in Washington. "Our economy is still evidencing a good bit of strength."

Measured by the Fed's Trade-Weighted Major Currency Dollar Index, the dollar has gained 4.7 percent so far this year after weakening for three consecutive years amid a combination of record trade and fiscal deficits and the lowest interest rates in four decades. A fourth annual drop would be unprecedented since the end of the Bretton Woods system of fixed exchange rates more than three decades ago.

"The dollar is coming back," said Stephen Jen, head of global currency research in London at Morgan Stanley, the world's largest securities firm by market value. "What has happened to the evil twin deficits? Nobody is talking."

The U.S. trade deficit, the amount by which imports exceed exports, unexpectedly shrank in March to $55 billion, the smallest in six months, the Commerce Department said on Wednesday. The following day, a report showed retail sales in March rose 1.4 percent, twice the median forecast in a Bloomberg News survey.

Signs of faster economic growth suggest the Fed will add to its eight rate increases since June and further spur the dollar, said Luke Waddington, head of currency sales in Tokyo at Royal Bank of Scotland Plc.

The Fed on May 3 lifted the interest-rate target for overnight loans between banks by a quarter point to 3 percent. The European Central Bank has kept its benchmark rate at 2 percent since 2003. The spread between two-year Treasury notes and German bunds of similar maturity has widened to the most since 2000.

"Right now it's easy: Buy dollars," said Waddington. The dollar may rise to $1.2550 per euro this week, he said.

The dollar may be vulnerable precisely because sentiment has shifted so much in its favor, said Tony Norfield, head of global currency strategy at ABN Amro Holding NV in London. Information from customers suggests hedge funds and other large speculators have the most bets on the euro's drop in 12 months, he said.

Futures traders reversed their bets that the euro will gain against the U.S. dollar, figures from the Washington-based Commodity Futures Trading Commission show. The difference in the number of wagers on a decline in the euro compared with those on a gain -- so- called net shorts -- was 1,544 on May 10, compared with net longs of 4,875 a week earlier.

The last time CFTC figures showed speculators ended bets on the dollar's decline was Feb. 11. The dollar fell by a cent against the euro the next trading day. "Everyone on the sell side's jumping over," said David Mozina, a strategist at ABN Amro in Sydney. "It may suggest this trend tires a bit."

Some investors may also sell dollars should a Treasury Department report today show international investors purchased fewer U.S. assets in March, said Daniel Katzive, a currency strategist at UBS AG in Stamford, Connecticut. He made the comments in a report on Friday.

Foreigners probably bought a net $70 billion in Treasury notes, corporate bonds, stocks and other financial assets in March, down from $84.5 billion in the prior month, according to the median estimate of economists in a Bloomberg survey.

Bloomberg's weekly currency survey accurately predicted last week that the dollar would gain versus the euro and wrongly indicated the yen would strengthen. It correctly forecast the direction of the dollar in 17 of the past 26 weeks versus the euro and in 12 weeks against the yen.

The dollar's rally against the euro may extend to $1.24 by the end of the month as U.S. economic growth exceeds Europe's, said John Taylor, chairman of FX Concepts Inc., a New York firm that manages $12.1 billion in currencies.

"Europe is sick," said Taylor. "The euro can't take the heights. The U.S. economy is quite a bit stronger."

The European Commission on Thursday cut its forecast for second- quarter growth in the euro region to 0.4 percent from 0.5 percent, the same day a government report showed Italy's economy entered recession. France's economy probably grew 0.5 percent in the first quarter, down from 0.9 percent, according to the median estimate of economists polled by Bloomberg. The report is due to be released on Friday.

Thirty-one percent of survey participants said to buy the yen against the dollar and 44 percent advised selling. The rest recommended holding. The yen's drop last week was limited by speculation China will loosen its fixed exchange rate to the dollar, which may make Asian central banks more tolerant of stronger currencies.

"The China revaluation issue is going to linger, which may help the yen at some point," said Toru Umemoto, chief currency analyst in Tokyo at Barclays Plc. Umemoto said the dollar may rise to 109 yen next week.

Contributing: Vivianne C. Rodrigues, Joshua Krongold, Daniel Moss, Brian Swint, James G. Neuger, John Brinsley, Chris Cooper, Keiko Ujikane, Kazumi Miura and Bharat Ahluwalia

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