FOREX VIEW: Tinderbox Of War Concerns To Weigh On Dollar

sg.biz.yahoo.com Monday January 13, 6:00 AM By Grainne McCarthy Of DOW JONES NEWSWIRES

NEW YORK (Dow Jones)--Having fallen swiftly on the back of some surprisingly weak U.S. employment data, the dollar is set to remain under pressure this week, increasingly vulnerable to the drumbeat of war surrounding Iraq and nuclear saber-rattling in North Korea.

"People are positioned for Armageddon on the dollar, in that scenario you can get whacky moves," says Paul Podolsky, chief strategist at Fleet Global Markets in Boston.

Investors unsure of the dollar's vulnerability to U.S. economic data got a resounding wake-up call Friday, with the currency tumbling swiftly after the government reported a dismal December payrolls report that fueled concerns about the lingering soft spot dogging the world's largest economy. The dollar hit a fresh three-year trough against the euro, while sliding to its weakest point against the Swiss franc in four years.

Late Friday in New York, the euro was at $1.0574, up steeply from $1.0488 late Thursday. Against the Swiss franc, the dollar was at CHF1.3802, sharply down from CHF1.3909 late, while sterling was at $1.6082, modestly up from $1.6061 late Thursday. The dollar was at Y119.20, modestly lower than Y119.26 late Thursday in New York.

Even as Canada reported another remarkably strong month of employment growth, job losses in the U.S. soared to 101,000, disarmingly far from consensus forecasts for a modest increase of 20,000.

There were clearly some seasonal explanations for the massive leap but the report still further underscored a view that the sluggish U.S. economic recovery isn't creating jobs, potentially boding ill for the dollar at a time when it's already being undermined by war concerns.

"Until Iraq goes away and the outlook for consumer confidence and business spending improves, the dollar is going to remain under pressure," said Jay Bryson, global economist at Wachovia Securities in Charlotte, N.C.

There will certainly be plenty of economic data this week for dollar investors to sink their teeth into, with the focus most likely on somewhat stronger economic activity and benign inflation. Headline retail sales for December - to be reported Tuesday - are expected to come in very firm, mostly thanks to the 18% jump in auto sales already reported. But excluding autos, economists anticipate just a 0.3% increase.

The U.S. will also see December's producer price and consumer price indexes on Wednesday and Thursday respectively, while the focus for Friday will be squarely on the initial University of Michigan consumer sentiment report for January, which should provide a glimpse of how confidence is holding up amid growing war jitters.

But aside from the clear significance of much of this data, many analysts expect the dollar to look more to the Pentagon, State Department and ultimately the White House for signposts for near-term direction.

As the central emblem in financial markets of the world's only superpower, the dollar is beset by multiple threats to global stability that are simultaneously breaking out on several fronts. As well as the situations in North Korea and Iraq, the ongoing battle against terrorist network al-Qaida is high on the list of nightmarish issues facing the Bush administration. The U.S. - given its position of global hegemon - has almost by default become the first line of defense in tackling these challenges.

"Connect the dots and what emerges is hardly encouraging for the dollar in particular and the financial markets in general," said Joseph Quinlan, global economist at Johns Hopkins University in Washington.

He argues that investors in U.S. assets, while certainly cognizant of war risk, may have priced in an overly rosy scenario under which the war on terrorism has already been won, the war against Iraq has already been priced in and a war on the Korean peninsula is too remote a possibility to take seriously.

An upset to this more optimistic picture could weigh much more heavily on global capital flows, ultimately depressing the dollar given the U.S. status as a creditor nation dependent on capital inflows to finance the current account.

Indeed, some analysts believe the dollar's swift reaction to the jobs data raises the question of whether the currency might be headed for a more precipitous slide, which has the potential to ripple more heavily over into other U.S. asset markets, while also raising alarm among policy makers.

"We've had a pretty quick move here and a lot of people are scratching their heads and asking if the speed of adjustments might be more than they've already anticipated," said Marcel Kasumovich, head of G-10 currency strategy at Merrill Lynch in New York. "Especially if you start to see a feedback to interest rates or equity markets, that sends a warning signal to central banks that maybe there's a confidence issue."

For now, that's not happening, but the tenacity of the euro's gains could have clear consequences for U.S. fixed income markets. A stronger euro only enhances the appeal of European sovereign debt, which many global fund managers have been advocating for months as much more appealing than Treasurys, particularly with expectations that the European Central Bank still has some room to lower interest rates.

Already currency analysts are talking about the euro reaching as high as $1.10 this month, a dramatic contrast from just a couple of weeks ago when a survey of major currency dealing banks predicted the euro only scaling those heights at the end of this year.

Elsewhere, the focus this week will once again be on Venezuela, after the bolivar tumbled last week amid some panic buying ahead of a 48-hour bank strike. The currency did rebound on Friday, but remains vulnerable to further instability, with the general strike, which began Dec. 2, lingering.

-By Grainne McCarthy; Dow Jones Newswires; 201 938 2381; grainne.mccarthy@dowjones.com