Dollar bounce on profit taking

The dollar continued to gain lost ground on the euro as falls in equity markets prompted investors to act decidedly to cut down on risky positions.

The dollar benefited from safe haven type flows what with Wall Street opening lower, further denting sentiment after major European and Asian bourses all ended down amid concerns about the impact of the sub-prime crisis on the US and global economy.

While concerns about the US economy also weighs on the dollar, no part of the global economy is expected to escape unscathed, in turn leading to widespread risk aversion.

The current market sell-off is especially more dire than the turmoil of February and August because of escalating probabilities of a US recession.

The yen has also been supported by increased investor caution, as market players shy away from the risky carry trade where they sell the low-yielding Japanese currency to invest in higher-yielding ones elsewhere. This in turn has pushed high yielding currencies such as the pound and Australian dollar lower.

Equity market woe is helping to weigh on the high-yielding pound, the dollar and yen are perceived to be more as safe-haven currencies than the pound, so it can be vulnerable when stocks fall.

However while the rise in risk aversion has given the dollar a boost, analysts still expect the greenback to remain weak in the long-term, especially following the notable absence of any comment on the currency at this weekend's G7 meeting.

The communique from the G7 gathering in Washington made no mention of the weak dollar, or indeed the yen, opting instead to call again for a faster appreciation of the Chinese yuan.

The dollar's fortunes will now depend on whether the Federal Reserve continues to ease its monetary policy stance. Most of last week's US data came in on the soft side and analysts expect to see a similar outcome in the coming days.

Apart from safe haven flows, the dollar is unlikely to find support this week as the cyclical data should remain weak and the market is likely to revise the probability of a US recession upwards. While no major data is scheduled for today, existing and new home sales due out on Wednesday and Thursday respectively are expected to show the housing market continuing to falter.

Elsewhere, the Canadian dollar fell back from recent 31-year highs on another outbreak of risk aversion in global markets, and also in response to weekend commentary from Bank of Canada governor David Dodge expressing concern about the speed of the currency's appreciation.