The dollar has been buoyed recently by a general feeling on the part of investors that Europe will likely lag the U.S. when it comes to a recovery.
If the European Central Bank and/or the Bank of England cut key interest rates, that would help keep cash flowing through those economies, but it would also devalue those currencies, according to Brian Dolan, chief currency strategist at online currency trading Web site Forex.com.
The U.S. currency surged against the pound, which fell 2.6 cents to $1.582 from $1.608 late Friday. The 15-nation euro fell 1 cent to $1.264 from $1.274. And the dollar rose against the Japanese yen, trading up ¥0.5 to ¥99.13 from ¥98.64.
The greenback also got a boost from Wall Street as U.S. stocks seesawed in a narrow range to end little changed.
The indecisive moves signaled ongoing risk aversion, which typically pushes investors toward the greenback. The U.S. currency is seen as a stable investment during times of economic turmoil.
European weakness: The European Union said it expected its economy to stagnate through 2009, and predicted GDP growth in the 15-nation euro zone to reach as low as 0.9% during 2010.
"The expectation is [the ECB] will cut," said Dolan. "We're basically heading into a global recession."
However, the EU outlook came as little surprise. "There's a lot of people that already expect the euro-zone to be in recession," said Dustin Reid, senior currency strategist at Dutch banking group ABN AMRO.
Stocks seesaw:U.S. stocks traded in a narrow range as investors remained wary.
The Dow Jones industrial average had dropped about 50 points after automakers such as Ford (F, Fortune 500), GM (GM, Fortune 500) and Toyota (TM) reported large drops in October sales. But the blue-chip index recouped those losses by the end of the session to close nearly unchanged.
Earlier in the session, the Dow had been up as much as 85 points.
Despite the relatively narrow range, investors remain on edge.
"There are still a lot of bad things in the closet," said to Dolan.
A key gauge of U.S. manufacturing activity showed that production in October fell to its lowest level since 1982.
Meanwhile spending on construction in September also dropped according to the Commerce Department, though the amount was less than expected.
White House race: Investors are also keenly awaiting the results of Tuesday's U.S. presidential election.
"A Democratic victory is likely to see a fair amount of optimism," said Dolan. That would bode well for the dollar, euro, British pound and Australian dollar - all of which would likely rise against the Japanese yen. The yen is often purchased as a hedge against risk.
But any moves in currencies should be taken with a pinch of salt.
"It's largely emotional at this point," said Dolan. "People are really desperate for some stability."
Looking further out, investors will be waiting to see who gets appointed as the next Treasury Secretary. That person will inherit the task of doling out and overseeing the economic bailout.
Japanese economy: In another sign that investors were gaining some confidence, the yen's weakness was partly driven by shifts into higher yielding currencies.
"People [are selling] yen to use as a funding vehicle" to buy other currencies which are riskier, but yield higher returns, said Reid.
The Bank of Japan's decision to cut its key interest rate for the first time in seven years Monday also helped weaken the currency, according to Reid.
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