Worries about the ability of highly leveraged countries, such as the United Arab Emirates, Greece and Spain, to pay their debt is expected to boost the US dollar next week as investors seek safety. Risk appetite will remain a key driver for the dollar, whose safe-haven qualities remain intact, despite a week packed with US economic data and the outcome of a two-day Federal Reserve policy-setting meeting on Wednesday.
Few analysts, however, expect the Fed decision, or the accompanying statement highlighting policy-makers' views on the economy, to move the market, with most traders focused on the impact on the market of risks related to sovereign debt.
"The extension of dollar strengthening into the end of the week appears mostly related to (sovereign debt) concerns and is thus indicative of risk appetite remaining a driving force for the dollar," said Todd Elmer, currency strategist at CitiFX in New York.
The fallout from the debt crisis in Dubai, part of the United Arab Emirates, which erupted a few weeks ago, continues to affect the market and is reinforced by doubts about capacity of other nations to pay. The downgrade of Greece by Fitch on Tuesday and Standard & Poor's shift in its the outlook for Spain to negative a day later have added to worries about possible insolvency among highly-leveraged countries.
These events have helped push the dollar to its second straight week of gains against a basket of six major currencies. On the week, the ICE Futures' dollar index rose 1.2 percent and up 2.3 percent the last two weeks. The euro, on the other hand, was down 1.8 percent this week, for a total fall of nearly 3 percent in the last two weeks.
Some analysts warned that the euro's correlation of rising in tandem with the stock market and increased risk appetite has been somewhat shaken since the release of an unexpectedly encouraging US non-farm payrolls report for November. On Friday, the single euro zone currency's positive correlation with the S&P 500 had fallen to 30 percent from a high of 93 percent in early October.
UPBEAT US DATA Following the trend of a shift in the euro's correlation to increased risk appetite, the dollar rose against the euro on Friday, climbing along with stocks, on strong US retail sales numbers and an upbeat University of Michigan consumer confidence report.
Still, analysts said the risk factor driving currencies is likely to remain intact until the end of the year. Monday could be a red-letter day for investors. They will be watching whether the property arm of state-owned Dubai World, will be able to make its loan repayments and settle all outstanding bills in full. Nakheel, the Dubai World subsidiary at the center of the emirate's debt storm, has a $3.52 billion Islamic bond due on Monday.
Failure to make a repayment could roil global financial markets and prompt investors to seek shelter in the US dollar once again, analysts said. Overall, markets should be prepared for a regime shift where the dollar could trade more on interest rate expectations, rising on good economic news and falling on dour data. But that is more like a 2010 story.
The Fed, meanwhile, will take center stage next week, but few expect fireworks. "We don't see much change in the language. Bernanke has already said the Fed is not going to remove the reference to keeping rates low for an extended period," said Vassili Serebriakov, senior currency strategist, at Wells Fargo in New York.
Indeed, a speech by Fed Chairman Ben Bernanke on Monday, just days after the November payrolls report, suggested that the road ahead for the US economy is anything but straightforward. Serebriakov said that while the policy statement from the Federal Open Market Committee at the close of the Fed meeting, "could be negative for the dollar, I doubt whether it would have that much of an impact."
He added that the technical picture for the dollar has become more favourable. "If the euro could break above $1.4850...it may change the technical picture in the near term," he said, "but if we close at current levels below $1.47 then that's positive for the dollar." The euro, however, has had difficulty getting above $1.48 and on Friday was down 0.9 percent at $1.4599. Traders said the pair could go to $1.44.