The dollar climbed against the yen but slipped against the euro on Friday as investors unraveled bets on the Japanese currency and staked out positions ahead of an election in Germany on Sunday. Earlier in the session, investors were captivated by a report showing robust capital flows into US assets in July.
The latest Treasury International Capital report showed a net $87.4 billion flowed into US securities in July, more than enough to cover the month's trade deficit of $57.9 billion. June's net inflow was revised up to $80.9 billion. But by early afternoon, traders were more focused on unwinding positions based on political events.
"Some of these guys are caught on the wrong side of the trades that (Japanese Prime Minister) Koizumi has a mandate and the perception that the election in Germany over the weekend is going to be muddled," said Grant Wilson, a trader with Mellon Bank in Pittsburgh.
The dollar jumped to a two-week high of 111.46 yen.The euro had its best single-day rise against the yen in over a month, rising over 0.8 percent to 136.42 yen. Opinion polls show German conservative leader Angela Merkel may not win an outright victory over Chancellor Gerhard Schroeder, raising the possibility of a "grand coalition" government that could slow the passage of market-friendly reforms.
Market talk of an investor defending a two-week euro/dollar double-no-touch option with triggers at $1.2200 and $1.2500 may have prompted demand for euros, traders said.
The euro was up 0.1 percent at $1.2232. In addition, the market's inability earlier in the session to reach automatic sell orders at $1.2170 may have caused some investors to throw in the towel, traders said. Sterling was up 0.1 percent, at $1.8076.
In an ominous development for the dollar, gold prices - which tend to move in inverse correlation to the dollar - rose to a 17-year high of $460.10 an ounce as investors became increasingly concerned about rising global inflation.
Despite the greenback's mixed performance, the heavy flows into dollar-denominated assets in July were supportive of the currency.
"As we have noted, reduced dollar sensitivity to positive real-side data surprises signals that the dollar will have few legs to stand on upon structural deterioration into the end of the year, but continued positive capital inflows could forestall a period of sustained dollar adjustment," Citigroup currency strategist Todd Elmer said in a note to clients. The US current account deficit in the second quarter was the second-largest on record at $195.7 billion, narrower than the revised $198.7 billion in the previous three months but more than the $193 billion forecast by economists.
Still, while the gap may have narrowed in nominal terms, details in the report, such as net investment income balance slipping into the red and the upward revision in the previous quarter's deficit, were not encouraging for the dollar.
The dollar's prior three-year decline had been driven mostly by concerns over the sheer difficulty of having to finance such large trade and fiscal deficits. However, that decline apparently was halted this year as interest rate and growth differentials played to the dollar's favour.
The latest data for the week ended September 13 from the International Monetary Market showed the net US dollar short position versus six other major currencies was pared back to 38,994 contracts from 48,683 in the prior week.
Comments from Federal Reserve officials have suggested the key rate will rise on inflation concerns despite the damage caused by Hurricane Katrina, tilting market expectations in favour of an 11th consecutive quarter-percentage point hike to 3.75 percent on Tuesday.