Dollar, yen drop after U.S. home sales, Bernanke

The dollar and yen fell on Friday after a strong U.S. housing sales report and upbeat comments from Federal Reserve Chairman Ben Bernanke reduced the safe-haven appeal of the U.S. and Japanese currencies.

At an annual Fed conference in Jackson Hole, Wyoming, Bernanke gave his clearest signal yet that a recovery is at hand, although he warned that growth would be sluggish.

In addition, U.S. existing-home sales rose in July for a fourth straight month, and a euro zone service sector and manufacturing survey showed more improvement than expected. The data bolstered optimism about the global economy and lifted the euro to a two-week high versus the dollar. [ID:nN21378170]

"We've hit a bottom in the housing market. I think you're going to see further dollar and yen declines on that outlook," said Fabian Eliasson, vice president of currency sales at Mizuho Corporate Bank in New York.

"As conditions improve both here and in Europe ... there's less need for safer-haven currencies as the yen and dollar have been in the past year. The market moves into riskier assets."

In late New York trading, the euro rose 0.6 percent at $1.4333 EUR= after hitting a session peak of $1.4375, the highest since Aug. 7, according to Reuters data. It was also up 0.7 percent at 135.18 yen EURJPY=R.

"Both (Bernanke and housing data) were more bullish than what the market was looking for. The market is just taking those headlines as extreme positives for the outlook both in the U.S. and globally," said Jacob Oubina, currency strategist at Forex.com in Bedminster, New Jersey. "It's back to the whole risk-on trade."

The dollar was up 0.1 percent at 94.29 yen JPY=, off a session high of 94.71 yen, after trading as low as 93.40 yen.

Dollar Hits August High Vs Euro, Low Vs Yen

The dollar rose to it highest level this month against the euro on Monday but fell to an August-low versus the yen, as investors sought the safety of lower-yielding assets amid a drop in global stock indices.

The appetite for risk retreated after disappointing U.S. data releases last week and another U.S. bank failed over the weekend.

This has dragged down world stocks and sent traders back to the currencies in which they typically use to fund riskier bets - the dollar and yen. As a result, the euro declined to $1.4045 - its lowest level since July 30. The dollar fell to Y94.19, its lowest rate since July 29.

"The market's overwhelming bet of late that the seemingly straight-line path to economic prosperity would continue is now being drastically unwound as dollar bears are squeezed out of their highly-leveraged currency positions," said Mark Frey, head foreign exchange trader at Custom House.

The latest U.S. Treasury flows data are also dollar supportive, although they had little market impact Monday morning. Foreign demand for long-term U.S. financial assets grew in June much more than expected.

"Many were concerned that in recent months there was much more interest in the short end than long end," said Marc Chandler, head of global foreign exchange strategy at Brown Brothers Harriman in New York. "This big jump in the long end is a mind-blowing number, like almost five times more than the market expected."

"This could help dollar sentiment," he added.

Other higher-yielding currencies that have attracted a large amount of speculative positioning, such as the Australian dollar, Canadian dollar and Mexican peso, are also under pressure versus the greenback Monday.

Chris Turner, head of foreign exchange strategy at ING Financial Markets in London, said that the correction in the Aussie dollar could be used as a guide for the euro. The Australian dollar was recently trading at $0.8197.

"Below $0.8080/$0.8100 risks a sharper sell-off," said Turner.

However, analysts question whether this paring of risk is anything more than a blip of profit-taking.

"[Thin] summer markets imply a lack of desire to push crosses too far in either direction," said Stuart Bennett, a senior foreign exchange strategist at Calyon in London. "Hence, it is difficult to see the week's events producing any fresh direction for the foreign exchange markets."

Late Monday morning in New York, the euro was at $1.4080 from $1.4190 late Friday, according to EBS via CQG. The dollar was at Y94.32 from Y94.83, and the euro was at Y132.82 from Y134.53. The U.K. pound was at $1.6295 from $1.6537, and the dollar was at CHF1.0794 from CHF1.0730.

Regulators seized Colonial Bank on Friday after reaching a deal to sell its branches, deposits and most of its assets to rival BB&T Corp. in the fifth-largest bank failure in U.S. history. It was the latest sign that while large institutions may be stabilizing, tension remains for regional lenders.

Meanwhile, U.S. consumer confidence data last week, as well as retail sales, came in worse than expected.

Although euro-zone gross domestic product surprised to the upside, thanks to France and Germany, other countries in the region remain under severe pressure.

Japan growth data overnight was somewhat positive, but fell short of economist expectations. Japan's economy grew for the first time in five quarters in the April-June period, with real gross domestic product up 0.9% from the prior quarter.

Elsewhere, in another sign that China may be attempting to diversify from its reliance on the dollar, the government said Monday it will expand a trial in which cross-border trade transactions are settled in yuan to the northeastern part of the country, state television reported.

The Canadian dollar is down after falling to a four-week low overnight in line with weaker global equity markets and sustained risk aversion.

Currency strategists at TD Securities said Monday that the recent upward lurch for the U.S. dollar-Canada pair appears to have forced some market players to the sidelines to re-assess, adding to the illiquidity and erratic volatility for the pair.

They said that the U.S. dollar's rise to its recent high took place "with relative ease, and while this may reflect a lack of liquidity and interest as much as the stronger U.S. dollar tone, it does suggest that the main near-term risk is higher."

Dollar May Hold Strength From Friday's Rally

A full slate of U.S. economic data next week will test the freshly minted view that the dollar is beginning to benefit from signs of economic recovery, reversing a market tendency that has held over the past year of recession.

The dollar and stocks both rallied sharply on Friday when the U.S. employment report for July came in better than expected, igniting a fresh round of investor optimism.

The tide of funds into the dollar was driven by the notion that a reviving U.S. economy may be ready to spearhead a climb out of the global downturn, which would also mean a quicker return to higher U.S. interest rates. This emergent view derailed the previous trend of positive data surprises igniting a thirst for riskier assets at the expense of the safe-haven dollar.

"This was maybe a hint of things to come for the dollar," said currency strategist Sacha Tihanyi of Scotia Capital, even if the greenback's longer-term outlook remains murky at best. "We are eventually going to reach a point where the risk flow won't push things around as much, and we may be closer to that point now."

If so, there will be abundant opportunities to test that proposition in the U.S. data flow next week. It will also help ascertain if Friday's break higher for the dollar was only fleeting or marks a decisive trend reversal.

Key U.S. data include the goods and services trade balance for June on Wednesday, July retail sales and the latest jobless claims figures Thursday, followed by the July consumer price index, industrial production figures for the same month, and a key measure of consumer sentiment on Friday.

Other significant events are the announcement at the end of the Federal Reserve's two-day policy meeting on Wednesday, as well as the market reception given the Treasury's massive $75 billion quarterly refunding effort over the course of the week.

The Fed next week isn't expected to deviate from its commitment to hold its key policy rate at exceptionally low levels for a prolonged period nor to fine tune its $1.75 trillion asset purchase program.

But crucial for currency and other asset markets will be whether the Fed's updated economic prognosis together with next week's data stream advances the likelihood of a U.S.-led global recovery and more favorable yield spreads between U.S. debt instruments and competing foreign assets.

"If the U.S. economy begins to lead the global economy out of recession, the dollar could benefit as it did in the wake of the Southeast Asian crisis of 1997-98," when the greenback was the preferred currency in the subsequent period of recovery, said chief currency strategist Michael Woolfolk of Bank of New York-Mellon.

Currency strategists at Brown Brothers Harriman said a sustained turnaround for the dollar may have to await a more consistent flow of better data and upwardly revised projections for U.S. economic growth, coupled with a rise in short-term Treasury yields above euro-zone counterparts.

More in the near term, Scotia Capital's Tihanyi expects the dollar to at least consolidate at stronger levels against its major rivals next week, suggesting a range of about $1.4000 to $1.4350 against the euro and Y95.80 to Y98.50 against the yen.