The dollar was largely unchanged against the euro and yen Thursday, erasing overnight losses after a report showed enough U.S. private sector job growth to ease fears about Friday's payrolls data.
However, analysts said the outlook for the dollar was still grim, especially after Wednesday, when it posted its biggest daily decline against a basket of major currencies since May 2006.
The yen overnight rose to a five-week high against the euro and dollar as investors sought relative safety for fear that a slowing U.S. economy may also put the brakes on global growth.
"With any fall in euro and yen, we would be buying those against the U.S. dollar because the outlook as far as we're concerned is going to continue to deteriorate," said David Mozina, head of foreign exchange strategy with Lehman Brothers in New York.
The dollar traded at 109.55 yen, well above overnight lows of 108.26 yen.
The euro traded largely unchanged against the dollar, at $1.4733. Against the yen, the euro was also relatively unchanged at 161.40 yen .
The New York Board of Trade's U.S. dollar index was trading flat on the day at 75.962 but overnight touched a one-month low of 75.708.
A run of weak U.S. data, including news Wednesday of contraction in the manufacturing sector in December, has prompted dealers to fully price in a 25 basis point cut in the Federal Reserve's benchmark interest rate at the end of the month, and a roughly one-in-five chance of a bigger 50 basis point move.
The yen has been one of the biggest gainers among major currencies in the last few days, even though Japan has the lowest interest rates in the industrialized world. The combination of higher volatility in markets, shifting global interest rate expectations and difficult lending conditions have all spurred risk-averse investors to unwind carry trades that use cheaply borrowed yen to buy higher-yielding assets.
For example, last month sterling had its largest monthly fall against the yen since March 2004.
The dollar has fallen precipitously against the yen since the end of December. Dealers are likely targeting the 107.20 yen low hit in November, said Jeff Sakamoto, currency trader with Union Bank of California in Los Angeles.
"If we get back down there, the market will take it out and go lower," he said.
Adding to investors' unease about the global growth outlook, the price of oil rose to $100 a barrel and gold rose to a record high above $850 an ounce.
The dollar fell against the Swiss franc by 0.4 percent to 1.1135 francs. The Australian dollar, which has been a popular target of carry trades, was down 0.1 percent at US$0.8820.
Traders said currency moves were accentuated by relatively thin volumes, as not all market participants have returned from their Christmas and New Year holidays as yet.
Some analysts said the absence of yield-seeking outflows from Japan, which is on holiday until Friday, was also a factor propping up the yen in the first trading sessions of 2008.