The dollar has dropped sharply this year but many investors still hold overweight positions and could force the greenback to new depths against the euro as they scramble to sell. The dollar has tumbled 15 percent over the last 12 months to an all-time low of 1.59 per euro on March 17, and investors expect it to continue its slide.
The US economy has been battered by a collapse in the housing market and a banking sector severely wounded by the credit crunch, prompting fears of a full-blown recession. This has caused the Federal Reserve to pump liquidity into the market and slash rates by 300 basis points since September, undermining the yield appeal of the greenback and prompting heavy selling.
But many institutional investors have been left behind and still hold relatively long positions in dollars. Speculative investors like hedge funds have been quicker to adopt short positions but there is still scope for them to cut further.
This could herald fresh dollar lows against the European currency - analysts say it could plumb the mid-1.60s level - and prompt more calls from European politicians, concerned about the soaring costs of their exports, for intervention.
Based on a survey of asset managers who hold around $14 trillion in assets, State Street Global Markets estimates that institutional investors are now more heavily weighted in the dollar than they have been 69 percent of the time in the past.
"Institutional investors are still long the dollar and this is likely due to broad based capital repatriation as funds unwound hedges and bought back dollars," said Michael Metcalfe, senior strategist at SSGM.
"They are now actively unwinding these positions, a move that could take three to five weeks. This could see new highs for euro/dollar." While speculative investors are ahead of their institutional counterparts in terms of adopting short dollar positions, there is still plenty of scope for them to make more extreme bets against the ailing US currency.
Speculators increased bets against the US dollar to $22.4 billion in the week to March 18, up slightly from the $19.63 billion the previous week according to data from the Commodity Futures Trading Commission. "There are not excessive short positions in the dollar; there's nothing to stop it going further," said Martin McMahon, FX strategist at Credit Suisse in Zurich.