DJ Forex Focus

Risk may be driving currencies but what is driving risk?

That is the unanswered question that is leaving the dollar very much at sea.

As the summer months drew to a close, the U.S. currency showed signs of recovery against the euro.

Since then, however, it has stalled, showing little clear direction as investors continue to assess the U.S. and the global economic recovery.

In the past, good news was bad for the dollar as risk appetite improved and investors headed back into so-called higher yielding currencies such as the euro.

On that basis, recent signs that the global recovery isn't so strong, and that growth could well dip back again, should be good news for the dollar.

This week, for example, news that the U.S. Conference Board consumer confidence index fell back sharply last month, instead of showing a small increase as anticipated, has simply increased fears that the U.S. economy is flat-lining.

Even reports of a rise in U.S. house prices, which in the past would have helped to boost consumer confidence, are being dismissed. Much of the increase is being driven by tax rebates that run out in November, meaning the uptrend is unlikely to last.

Instead, markets are putting even greater emphasis on the level of unemployment, and suggestions that the latest non-farm payrolls figures due on Friday will show an even larger-than-expected 175,000 decline.

As Rob Carnell, chief international economist with ING Financial Markets in London, said: "A reversal of the labour market improvements of recent months could come as a shock to a market that increasingly expects good news to support it."

Stephen Jen of BlueGold Capital Management in London said this isn't just a problem for the U.S. "The main downside risk to my constructive view of the world is the speed of the recovery of the labor market," he said.

However, these concerns about the recovery are coming against a background of reassurance from central bankers that the current easy monetary-policy across the globe will remain in place until the recovery is established.

It is true that monetary hawks on the U.S. Federal Reserve as well as the European Central Bank have continued to warn about insidious inflationary risks. Earlier this week, Philadelphia Fed President Charles Plosser warned that the Fed's credibility will continue to rely on its ability to "take the necessary steps to prevent a second great inflation."

Nevertheless, investors are now convinced that major central banks will now keep markets flooded with liquidity until there is more concrete evidence of recovery.

As a result, bad economic news may no longer be good for the dollar as it could no longer mean an automatic fall in risk appetite.

On the contrary, some analysts are convinced that the euro will break higher against the dollar as risk-seeking trades will increase now that accommodative policy is here to stay a little longer.

All the same, investors still appear reluctant to strike out against the dollar in favor of the euro.

This could have something to do with the latest comments from senior central bankers suggesting that they mightn't be so keen to see the dollar resume its fall against the euro now.

"The solidity of the dollar is very important," ECB President Jean-Claude Trichet said earlier this week, sparking concerns that this may not be the time for risk-seeking investors to start betting too heavily on a euro rally against the U.S. currency.

The importance of official attitudes towards the euro was evident early Thursday in Europe when the single currency was sent reeling by a comment from the European Union's Economic and Monetary Affairs Commissioner Joaquin Almunia. He said the eurogroup will discuss the euro's appreciation to prepare its position for G7.




Click Image to Enlarge


By 0645 GMT, the euro had fallen to $1.4572 from $1.4636 late on Wednesday in New York, according to EBS. It was also down at Y131.14 from Y131.36.

The dollar was still up at Y90.16 from Y89.75 as disappointing U.S. economic numbers on Wednesday left equity markets a little weaker.