Dollar gains as global gloom spurs flight to safety

NEW YORK: The dollar rallied broadly for its best day in more than a month on Thursday and the euro tumbled to an eight-month low as mounting concerns about the global economy drove investors to seek safety and liquidity.

A dismal economic outlook from the US Federal Reserve coupled with new signs of slowing in China and Germany sent investors out of stocks and other bets on growth and into dollar-denominated assets such as Treasuries.

Market anxiety has also led to a steep sell-off in commodity-linked currencies that have fared well during global expansion, such as the Australian and Canadian dollars as well as emerging markets like the Mexican peso.

"I think the dollar's outlook is as fickle as the market. For now, people are seeing the dollar as a safe haven, as Japan and Europe are going through a political crisis and as China slows down," said Paul Dietrich, chairman and chief executive officer of Foxhall Capital Management in Orange, Connecticut.

Dietrich, who manages assets of just under $1 billion, has moved 60 percent of his portfolio into short-term US Treasuries as a hedge against uncertainty in markets and a global slowdown.

The ICE dollar index rose 1.5 percent, its largest one-day gain since early August.

The euro fell on lingering uncertainty about whether Greece will receive its next tranche of aid from its creditors, which is crucial to the country avoiding default.

Suggesting further losses, the euro zone common currency slid through the 50 percent retracement level of the move from the June 2010 low to the May 2011 peak, hitting a session low of $1.3384, its weakest since Jan. 20.

In mid-afternoon New York trade, the euro traded down 0.7 percent at $1.34690 on electronic platform EBS.

Implied volatility, a measure of the options market's expectations of price movements, in euro/dollar have swung higher to a roughly 2-1/2-year peak at 18.0 percent. Vols predict how much a currency may move up or down over a given time frame, providing the basis for an option's price. As vols rise, so do option prices.

Jens Nordvig, global head of FX strategy at Nomura Securities in New York, said the firm's target for euro/dollar in the fourth quarter is $1.30, but noted that the downside risk is "very significant" in the medium term.

The macro environment is such that euro/dollar could weaken further over the next three to four months, testing the lows from 2010 around $1.18, he said.

"Against this background we are adding to short EUR/USD exposure, in a way which provides significant leverage to a substantial depreciation in the next 3-4 months," he said.

The US Federal Reserve said Wednesday it will shift its portfolio toward longer-term debt to bolster the economy. The Fed's program, dubbed "Operation Twist", was intended to put more downward pressure on long-term interest rates.

Fueling risk aversion was the Fed's warning of "significant" risks to the economy.

An important dollar-positive by-product of the Fed's program is higher short-term rates. The Fed's not increasing the money supply supported the dollar.

"It's all risk-off. The markets have not taken what the Fed had to say about the economy very well," said Neil Mellor, currency strategist at Bank of New York Mellon. "The break below the $1.35 level for the euro/dollar could see it settle in a new $1.30-1.35 range in coming months."

Currencies linked to global economic growth declined, with the New Zealand dollar falling to its lowest level since May 17 and the Australian dollar slumping to its lowest level since March 17.

Meanwhile, consumer confidence in the 17 countries using the euro fell sharply in September.

Adding to the gloom, data showed the pace of business activity slowing in the euro zone's two biggest economies, Germany and France.

The dollar was down 0.2 percent against the yen at 76.290. With the yen not far from the record high of 75.94 set last month, investors are on high alert for intervention by the Bank of Japan to contain the currency's strength.

Copyright Reuters, 2011