Dollar, Yen Rise as Weak Data Erodes Risk Appetite

The dollar and yen rallied Monday as sharp declines in U.S., European and Chinese manufacturing activity unnerved investors and pushed world stock markets lower.

The U.S. and Japanese currencies have rallied over the last few months as investors reversed risky trades funded by cheap yen and dollar borrowings.

Investors have also sought dollars as they pinned their hopes on a substantial economic stimulus package from the incoming administration under President-elect Barack Obama.

The yen performed best against currencies of countries where central banks are expected to slash interest rates later this week, including the euro, sterling, and Australian dollar.

"The dollar is still trading off bad economic news, risk aversion, and repatriation flows," said Michael Woolfolk, senior currency strategist, at Bank of New York Mellon in New York.

"The respite we saw in dollar buying late last week has faded. The Dow is down, crude oil is down $3-$4 a barrel, so we're seeing very familiar trends in financial markets."

In midday New York trading, the dollar was down against the yen . The euro also fell against the yen .

The euro fell against the dollar while the ICE Futures' dollar index rose 0.4 percent to 87.032.

A decline in the U.S. manufacturing index for November to its lowest in 26 years and a steeper-than-expected drop in construction spending also weighed on the dollar against the yen.

The data showed "continued weakness in the U.S. manufacturing sector and it is also interesting to note inflation is all but non-existent given the prices paid component dropping to 25.5," said Greg Salvaggio, vice president of capital markets at Tempus Consulting, in Washington.

"On this basis, the U.S. economy continues to remain weak going forward and we will anticipate some dollar weakness as traders refocus on weak U.S. economic fundamentals," he said.

Global Manufacturing Weakness

Falls in the euro and other European currencies also accelerated after manufacturing activity in the euro area, which has already entered recession, hit a record low in November.

China's manufacturing industry slumped as well in November as new orders, especially from abroad, tumbled.

The resulting risk aversion took global share prices, as measured by MSCI's all-country index, down nearly 5 percent on the day.

U.S. stocks were also down sharply, led by a slide in financial shares.

Sterling was off 3.6 percent against the dollar at $1.4844, with its losses exacerbated after data showed UK manufacturing activity had shrunk at a record pace.

As the global economy slows, the Bank of England, the European Central Bank, the Reserve Bank of Australia and the Reserve Bank of New Zealand are all expected to cut rates by at least half a percentage point, diminishing the yield advantage of their currencies over the ultra-low yielding yen.

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Analysts expect those four central banks to cut rates aggressively to counter the threat of deflation and prevent the global financial market crisis from further undermining the world economy.

"Evidence continues to build suggesting these central banks have further aggressive monetary easing to undertake...to stem the risks of a dramatic shift in price expectations going forward," said Bank of Tokyo Mitsubishi in a research note.

Yen crosses reflected those expectations, with sterling/yen, Australian dollar/yen and New Zealand dollar/yen all down more than 3 percent on the day.

Investors will also keep an eye on the November jobs report Friday.

Analysts expect the non-farm payrolls data to show a 320,000 drop last month, according to a Reuters poll.

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