The dollar is likely to get a boost next week from safe-haven flows as jittery investors shun risky assets such as global stocks as prospects of a US recession mount. The currency could further benefit from renewed investor optimism following the US government's pro-active response to prevent a steep economic slowdown.
The White House on Friday unveiled a fiscal stimulus pa Analysts expect the dollar's positive stance to continue next week. "The US dollar seems to be getting a safe-haven bid as faltering equity markets lead to redemption's and some repatriation of capital," said David Powell, senior currency strategist at IDEAglobal in New York.
The dollar ended the week on a positive note against a basket of major currencies, up about half a percent, despite reports of losses at Merrill Lynch and Citigroup and news showing deteriorating fundamentals in the US housing and manufacturing sectors.
Pessimism about the US economic outlook has spread world-wide, with global equity markets taking a hit since the beginning of the year. In the United States, the S&P 500 has been down about 10 percent since the start of 2008.
"The currency market is not reflecting the deterioration in US fundamentals, though, especially interest rate expectations. Bernanke in his speeches has actually confirmed that the Fed will likely cut by 50 basis points at the end of January and yet the dollar has held up quite well," Powell said.
A key support for the dollar has been the euro zone's worsening economic outlook, analysts say. Recent remarks from European Central Bank officials, particularly Yves Mersch, a member of the ECB's Governing Council, suggested that the bank may have to abandon its tightening bias and embark on an easing policy much like the Fed.
Mersch said on Wednesday the ECB may have to revise down its growth forecasts for 2008, although the bank should remain flexible on interest rates with risks to euro zone inflation also increasing. That capped the euro's gains, as the currency struggled below $1.47 against the dollar, with markets possibly testing $1.46.
In terms of US economic data, investors will again focus on fresh housing data next Thursday, with existing home sales for December. Analysts polled by Reuters expect a drop to a 4.95 million annual rate.
"Existing home sales are likely to drop, adding to the sense of gloom over the US economy, and should not undo the increasingly dovish tone (of the Fed)," said Daragh Maher, senior currency strategist at Calyon in London.
"Yet the FX market continues to struggle as to how best to 'spin' the US news, the dollar threatened by weak data, but comforted by safe haven flows and the aggressive policy response," he added.
Central bank meetings will also gain the market's attention next week. The Bank of Canada looks likely to cut rates by a quarter percentage point next Tuesday from the current 4.25 percent, analysts said, reflecting Canada's vulnerability to a possible US recession.
In the meantime, the Norges Bank and the Reserve Bank of New Zealand will also hold monetary policy meetings next week. Data for these two countries continued to show stable growth and high inflation, but analysts expect their central banks to hold interest rates unchanged given the global financial turmoil and US uncertainty.