The US dollar extended gains early in the week, helped by firmer oil prices after increased military activity in the Gulf. The near-term data diary looks light, with the NFIB survey and home sales figures the main releases. Technical measures, however, are flashing overbought conditions: a short-term valuation model places the dollar overvalued against every G10 currency except GBP, where it is assessed at fair value. On an equally weighted basis, the USD is 1.1% overvalued versus the G10.
Despite stretched positioning, there is no clear macro or market trigger for a turn in momentum. Sticky Fed tightening expectations, relative to most other central banks, are described as limiting downside even if oil prices pull back, while weakness across global bond markets is seen supporting demand for a liquid defensive currency. Looking further out, the US midterms are framed as a potential dollar risk, though markets are said to have long priced in the possibility of Republicans losing control of Congress, with any precautionary positioning unlikely before late October.
Managing Dollar Overvaluation and Trading Momentum
We advise derivative traders to avoid rushing into aggressive short positions against the US dollar simply because technical models signal it is overbought. Although valuation models show the greenback is roughly 1.1% overvalued against major peers, strong momentum can easily persist without a clear macro trigger. Historically, when the dollar index reaches overbought levels with a relative strength index above 70, it can still extend gains by another 2% to 3% before turning lower.
We see solid underlying support for the dollar coming from sticky central bank interest rate expectations and weak global bond prices. Rising energy prices from Gulf activity continue to feed inflation fears, keeping the greenback attractive as a liquid defensive asset. For now, we recommend holding cautious bullish exposure using call options or strict risk limits rather than trying to top-pick a reversal.
Preparing For Midterm Risks and Volatility Management
Further into October, we need to monitor rising political risks ahead of the upcoming US midterm elections. Historical trading data indicates that currency market volatility typically spikes by 15% to 20% in late October as traders hedge against potential congressional shifts. We suggest using multi-leg option strategies to manage sudden volatility spikes if political uncertainty begins to weigh on dollar strength.
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