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Dollar Drops as Investors Rethink Carry Trade

The dollar fell as government bond yields dropped today in a sign that investors' comfort with being in riskier, higher-yielding trades remained fickle ahead of U.S. economic data this week.

Falling German and Treasury bond yields on U.S. subprime mortgage market concerns fueled additional weakness in the dollar and strength in the low-yielding yen and Swiss franc.

The dollar had given up its gains from Friday after solid U.S. employment data rejuvenated carry trades, in which investors borrow cheaply in currencies with low interest rates such as the yen and invest elsewhere.

"I wouldn't say investment in risk is a trade that is going to go out of favor. I'd have a tendency to think the opposite," said David Durrant, chief currency strategist with Bank Julius
Baer & Co. in New York. "But day to day, it's going to be a bumpy ride against the yen."

The dollar fell to an intraday low of around 117.20 yen before paring some losses.

Dealers said a lot of the price action in the dollar was being governed by non-dollar currency pairs. In particular, a large central bank had been selling sterling and buying yen, sparking yen strength against other currencies.

The dollar tumbled 0.8% against the Swiss franc and the euro edged down 0.3% versus the Swiss franc.

The Word is Caution

The dollar's positive sheen from a relatively strong U.S. nonfarm payrolls report last Friday was unable to create sufficient momentum for the greenback today as investors continued to weigh recent volatile conditions where global stocks tumbled and the yen rallied sharply.

"The nonfarm payrolls on Friday is tempting risk appetite to recover cautiously, but it's certainly not 'all systems go,"' said Mike Moran, currency strategist with Standard Chartered in New York. "There's a fair amount of caution in investors' minds at the moment."

Furthermore, problems in the U.S. high-risk mortgage market pushed up Treasury prices and took some yield support away from both the dollar and the euro.

Against the dollar, the euro weakened 0.5%. So far this year, the euro has remained within a trading range of roughly $1.33 to $1.2865.

While an upward revision to Japan's economic growth data for the fourth quarter of last year supported the yen overnight, market participants have largely been concentrating on the investment environment for risk, while shrugging off fundamentals.

This week's U.S. retail sales and inflation data, if significantly outside of expectations, could coax the market back to looking at economic growth prospects.