The dollar declined across the board on Tuesday, while the euro rallied as investors began
the new year hunting currencies with rising yields.
The dollar's losses were most pronounced against European currencies such as the euro, sterling and the Swedish crown, where central banks are seen as likely to keep raising interest
rates in 2007, narrowing the gap with U.S. interest rates.
Liquidity was significantly thinned on Tuesday by a market holiday in Japan and closure of the U.S. stock market to commemorate the death of former President Gerald Ford. Currency trading also wound down early in the United States, analysts said.
"At this juncture of the new year, it's a yield story," said Ron Simpson, director of currency research at Action Economics in Tampa, Florida. But "there was very little indication overnight of significant flows and people are just jockeying for position."
The euro on Tuesday added to an 11.5% gain against the dollar in 2006, its best performance in three years.
The euro also rose to yet another record peak against the Japanese yen, rising as high as 157.90 yen, according to EBS, an electronic trading platform. It also rose to a near
seven-year high of 1.6121 Swiss francs, according to Reuters data.
"The Swiss franc and the yen are still fairly weak versus the euro, indicating that risk appetite in the market is high and carry trades are very much in vogue," said Michael Klawitter, currency strategist at Dresdner Kleinwort in Frankfurt.
Indicating the continued popularity of carry trades, in which investors sell low-yielding currencies for high yielders, the Australian dollar hit nine-year highs above 94.50 yen.
The dollar also lost ground against the yen.
Japan's Yomiuri newspaper reported on Tuesday that the Bank of Japan would consider raising rates at its policy meeting on Jan. 17-18, but added a hike might be delayed depending on "adjustments" between the BOJ and the nation's ruling parties.
Meanwhile, financial markets are pricing in at least one rate cut for the United States in 2007, although surprising strength in some recent data has pushed out the expected timing of such a move.
"Another few rounds of decent data and Treasury yields will price out a rate cut and that will be good for the dollar," said Action's Simpson.
The minutes of the Federal Reserve's December policy meeting may help shed some light on the outlook for rates. The minutes had been due to be released on Tuesday but the release was pushed back to Wednesday due to the national holiday.
The Institute for Supply Management's reading on the U.S. manufacturing sector is also due on Wednesday, while Friday brings the closely watched nonfarm payrolls report for December.
A reading below 50 in the manufacturing ISM index -- which dipped below the boom-or-bust level for the first time in three and a half years in November -- would likely reinforce concerns
about an economic slowdown, hurting the dollar further, analysts said.
"This week's ISM reports on manufacturing and services will be crucial in determining the euro's momentum towards last year's 1.3367 highs," said Ashraf Laidi, chief FX analyst at CMC Markets in New York.