Dollar Weakens on PPI, European Situation

The US dollar index traded lower early Wednesday, continuing a trend that saw the dollar index fall slightly on Tuesday. The index moved below the $81 price level.

The shift in the dollar index may have been caused primarily by gains from the euro against the dollar. The EUR/USD pair rallied nearly 1.40% on Tuesday, as European markets moved slightly higher. Rumblings that negotiations between Greece and its creditors were near completion may have calmed investors' fears.

Short interest against the euro is currently near record levels. The significant gain seen on Wednesday morning may have been the result of a short-covering rally. If this is the case, traders may anticipate the euro moving higher from here.

Of course, the euro could come under continued pressure in the even that the situation in the Eurozone continues to deteriorate. While the news coming out of Greece appears to be positive for general European stability, thus far nothing has been confirmed.

Should Greece default in a disorderly manner, it could lead to a further shakeup in the region and a flight to safety out of the euro currency.

At the same time, forces within the US may be pushing the dollar's relative value lower.

Core producer price inflation increased in December, up to an annualized rate increase of 3.0%—the quickest rate of increase in about 36 months.

That quickening pace of inflation could signal a weaker dollar, as the purchasing power of the dollar declines in the face of rising inflation. Should evidence continue to demonstrate a quickening pace of inflation in the US economy, the dollar index could continue to move lower from here.

Yet, if traders accept the view of the World Bank, the dollar index's recent decline may just be a temporary phenomenon.

The World Bank warned on Tuesday that the global economy was at risk of a severe recession—on the level of 2008's global financial crisis. Citing dangers in the Eurozone, the World Bank trimmed its global growth outlook. The World Bank now believes that the Eurozone entered recession in the fourth quarter of 2011.

Should that prediction prove accurate, the dollar index could see significant strength in the coming weeks. The dollar index rallied tremendously in late 2008, as global fears may have prompted investors to run to the perceived safety of the dollar.

Still, 2012 has thus far proved to be a tremendous year for equities. Economic data has been mixed, with some evidence that the economic picture is improving. In that scenario—with the safety trade dead—$81 on the dollar index may come to be seen as a temporary high in a greater downward trajectory.

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