By William L. Watts & Lisa Twaronite, MarketWatch
LONDON (MarketWatch) -- Ideas the dollar was ready to rally in lockstep with signs of global economic recovery appeared premature Tuesday, as the U.S. currency continued to edge lower versus major rivals as global equity markets and commodities rallied.
"The dollar remained on the back foot overnight as the beginning of the year continued with the trend of rising optimism and risk-on trades ... As yet, the dollar is reacting negatively to good news, but this week should be a good test of the strength of that relationship," wrote strategists at Brown Brothers Harriman in a research note.
The dollar index (DXY 77.33, -0.20, -0.25%) , which tracks the U.S. currency against a trade-weighted basket of six major rivals, traded at 77.423, down slightly from around 77.503 in North American trading late Monday.
The dollar fell to 92.01 yen versus the Japanese currency, down from 92.54 yen late Monday.
The euro rose to $1.4427, up slightly from $1.4411 late Monday.
The British pound bought $1.6018, down from $1.6099.
European stocks were higher Tuesday, while U.S. stock-index futures pointed to a steady start for Wall Street after strong gains Monday on the first trading day of 2010. See Europe Markets. Read Indications.
The U.S. currency sank from March of last year as rising investor risk appetite drove global equities and commodities higher, leaving behind the greenback and other low-yielding currencies. Some analysts contended the dollar had also taken on a role as a funding currency for carry trades, which center on borrowing in a low-yielding currency and then using the funds to purchase higher-yielding assets.
At the end of the year, the inverse relationship between equities and the dollar appeared to break down. Both the dollar and equities appeared capable of rallying in lockstep, with dollar bulls arguing that the greenback was set to gain ground as the focus turned to ideas the U.S. Federal Reserve could move soon to withdraw liquidity and to raise interest rates from near-zero levels in 2010.
The dollar's gains in December, however, appeared tied in part to rising sovereign debt worries, said Elizabeth Gregory, market strategist at foreign-exchange broker ACM in Geneva. Those concerns prompted traders to unwind bets the dollar would continue its decline, buoying the greenback into year end.
Worries had mounted following Dubai's debt woes and downgrades of Greek government debt within the euro zone.
With equity markets powering ahead and commodities surging in the first two days of the new year, however, investors were eager to put their money back to work, she said, renewing interest in risk-oriented trades to the detriment of the dollar.
The euro had little direct reaction to data showing unemployment in Germany unexpectedly fell by a seasonally-adjusted 3,000 in December, marking the sixth monthly decline. Read about the German unemployment data.
The week's key event remains the Friday release of U.S. December non-farm payrolls data. Economists surveyed by MarketWatch expect payrolls to rise by 10,000, ending a 23-month streak of declines. Read Economic Preview.
Gregory said a much stronger than expected rise in payrolls could be sufficient to reverse the dollar's downtrend, noting that exceptionally strong upside surprises in U.S. data have tended to lead to dollar strength.
Meanwhile, Tohru Sasaki, chief foreign-exchange strategist for Japan at JP Morgan Securities in Tokyo, warned that the yen could be set to rebound versus the dollar if U.S. Treasury yields retreat from recent highs.
"We continue to believe that markets are pricing too aggressive a profile of Fed rate hikes," said Sasaki.
The benchmark 10-year U.S. Treasury yield has a "strong negative correlation" with the Japanese yen, Sasaki said in a research note.
That means that if the market expectations of Fed rate hikes were to weaken and 10-year yields start falling toward the bottom of their six-month trading range, the yen is likely to appreciate as 10-year yields fall, he said.
