Dollar May Be Looking More At Rates Now. By Nicholas Hastings

Cracks are appearing in the dollar's close correlation with risk.

For months, the negative relationship between the two has been crystal clear. Good economic news out of the U.S. boosts global appetite for risk and encourages investors to sell the dollar.

The reverse has been equally true. Poor economic news out of the U.S. encourages a return to safe havens and boosts the U.S. currency.

Some analysts are convinced that this relationship is growing ever stronger, with the dollar continuing to take its cue from the performance of equity markets--a key barometer of risk.

"In a scenario that still swings between risk aversion and risk appetite, any dollar pullback needs to be coupled with a sustained correction in U.S. stocks to be persistent," said the currency strategy team at UniCredit Markets and Investment Banking.

However, there is evidence that the contrary could be true.

Recent U.S. economic data simply haven't elicited the same response from the dollar as they have in the past.

Take last Friday's highly disappointing consumer confidence survey from the University of Michigan. Instead of showing a rise in confidence, the survey showed a fall, news that suggests that U.S. consumer activity is as weak as ever now that the cash-for-clunkers program is over.

Rob Carnell, chief international economist with ING Financial Markets in London, said this doesn't bode well for the economic outlook.

"It would make the consensus expectations for GDP growth for 3.0% in the fourth quarter of 2009 look very implausible," he said.

Even a strong upturn in retail sales Monday proved of little help. Underlying sales, once autos and gasoline were stripped out, remained subdued suggesting that overall economic activity will continue to disappoint.

Nevertheless, the dollar, which once would have benefited from a nervous investor response to all this negative news, declined once again.


Click Image to Enlarge


It could be argued that the market was focusing on good news elsewhere; Japan's GDP expanded at double the rate the market expected in the third quarter and the price of gold continues to rally to record highs as the outlook for global demand improves.

Daragh Maher, deputy head of global foreign exchange strategy at Calyon Credit Agricole in London, said this is evidence that risk appetite and confidence in the global recovery are getting stronger.

"As often as it is knocked over by a nugget of bad news, concerns over risk asset valuation or the vagaries of chartists, risk appetite comes bouncing back," Maher said.

On the other hand, it could be argued that the dollar is now suffering from concern that the U.S. Federal Reserve will be forced to preserve its emergency funding rates for even longer than expected.

If so, this will reduce any yield advantage that the dollar may have benefited from down the road and undermine support for the U.S. currency.

The currency strategy team at Commerzbank suggested that the dollar's reaction to the confidence data was more evidence of the market's focus on interest rates.

"Until markets evaluate U.S. economic data from the point of view of its effects on Fed monetary policy the recovery of the dollar will remain nothing but a correction rather than a turnaround," the team said.

Early Tuesday in Europe, the dollar was facing mixed fortunes after Fed Chairman Ben Bernanke gave a fairly dovish assessment of the U.S. economy but suggested that the Fed "will help ensure the dollar is strong."

Comments from the Reserve Bank of Australia that the pace of further rate hikes is an "open question" also helped to depress global sentiment and knock most Asian stock markets lower. The Nikkei lost 0.6% but the Shanghai Composite, which bucked the regional trend, rose 0.3%.

By 0745 GMT, the dollar had fallen to Y88.89 from Y89.08 late Monday in New York, according to EBS.

The euro fell to $1.4966 from $1.4972 and was also down at Y133.00 from Y133.34.