Dollar's Winter May Not Be As Nice As Summer. By Nicholas Hastings

The dollar may have escaped any nasty falls this summer.

But the big worry is the U.S. currency may not do so well this winter.

This will depend on two key factors.

The first is a likely rise in trading volumes and whether investors returning from their summer holidays are confident enough that U.S. interest rates are now headed higher.

The second is whether foreign central banks, which have continued to increase their dollar-denominated reserves, now start to lose their nerve.

Two things have changed while many investors have been away sunning themselves on the beaches.

Evidence of a global economic recovery has continued to grow. But with China showing signs of wanting to slam on the monetary brakes, and with the massive spending programs in many major economies coming to an end, there is rising concern that growth rates will not be maintained.

In fact, some experts fear that without some further fiscal injections, a sustained upturn may remain elusive for now.

The other change came from a shift in investor attitudes.

While recession concerns remained paramount, risk - or perceptions of risk - remained the prime driver for currencies. The dollar's safe-haven role ensured support as risk aversion increased and high-yielders lost their appeal.

However, this could be changing. As Stephen Jen, chief currencies investor with BlueGold Capital Management in London, pointed out: "In the past couple of weeks or so, the correlation between foreign exchange and general risk assets has declined considerably.

"Not only has the direction of the dollar become less sensitive to changes in risk, commodity currencies and the yen have also become less responsive."

So, as the summer ends and the volume of trading picks up, there can be no assumption that investor support for the dollar will continue.




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The problem is similar for those tracking support from foreign central banks.

Despite repeated warnings from China and other major players that they are worried the dollar will be undermined by the U.S.'s massive budget deficit, they have all spent the summer increasing their dollar-denominated reserves.

According to Simon Derrick, a senior currency strategist with The Bank of New York Mellon in London, the collective reserves of Brazil, Russia, India, South Korea, Taiwan, Hong Kong and Singapore have jumped by $170 billion, or 10%, in the five months to June. China's reserves alone grew by $219 billion, or 11%.

Derrick said there is good evidence to suggest their dollar reserves continued to rise during the summer, especially as this dollar support kept their own currencies weak and encouraged investment flows into their own stock markets.

However, the prospects of continued monetary weakness in the U.S. combined with the growing fiscal deficit will eventually take its toll and could well threaten the value of their reserves.

If that is the case, then diversification out of the dollar could well return as an issue that would make a nasty fall in the dollar later this year more likely.

Early Wednesday in Europe, the dollar was mixed to higher - benefiting in some places from a general improvement in market sentiment as good house price and consumer confidence data from the U.S. lifted global equities.

By 0645 GMT, the dollar had slipped to Y94.07 from Y94.15 late Tuesday in New York, according to EBS. The euro, which had risen as the Nikkei rallied 1.4% and the Shanghai Composite Index gained 2.1%, fell back again - down to $1.4311 from $1.4315 and to Y134.57 and Y134.77.