Dollar may fall on weak economic data

(Reuters) - The U.S. dollar may fall next week as recent weaker-than-expected economic data reinforces the view U.S. interest rates will stay near zero for some time, undermining the currency's yield appeal.

The euro, which rallied sharply this week, may extend gains above $1.27 in the near term, analysts said, as pessimism over European debt and funding problems eased with a break of key technical levels adding to bullish momentum.

After rising on risk aversion as a result of Europe's debt troubles in recent months, the dollar fell this week in tandem with losses in U.S. stocks, sparking speculation investors' focus may be shifting from the euro zone crisis to the possibility of a stalled recovery in the U.S.

"We are going to see further modest pullbacks in the U.S. dollar, but the euro is going to set the tone," said Ashraf Laidi, chief market strategist at CMC Markets in London.

"We may not be far from reaching a stage of concerted dollar decline because of the potential for the Federal Reserve prolonging (low) interest rates for a longer period of time."

On Friday, the dollar fell against the euro after a report showed a larger-than-expected drop in U.S. non-farm payrolls to 125,000 for June, even as the unemployment rate unexpectedly fell to 9.5 percent.

The U.S. jobs report follows weak housing, manufacturing and consumer confidence data earlier in the week.

On the week, the ICE futures U.S. dollar index .DXY, which tracks the greenback against a basket of six currencies, fell 1.1 percent, the fourth week of declines.

The euro gained 1.5 percent against the dollar this week reversing a loss from the prior week.

The dollar fell for the fourth straight week against the yen, losing an additional 1.8 percent and bringing the total loss over the four weeks to 4.5 percent.

"The market's emphasis on the European debt crisis eased and the macroeconomic concerns grew," said Marc Chandler, global head of currency strategy at Brown Brothers Harriman in New York. "In the near-term the focus on macroeconomic challenges is dollar negative."

The inverse relationship between the dollar and equities showed signs of breaking down this week, as both Wall Street and the greenback fell. For the past several weeks, the dollar has tended to rise when stocks fell on safe haven bids.

The 25-day correlation coefficient between the S&P 500 index and the U.S. dollar index .DXY was positive 0.04 on Friday, Reuters data showed, showing almost no relationship. In mid-May, the correlation was a strong negative 0.91.

BULLISH MOMENTUM

Chart analysis points to further gains in the euro above $1.27 in the near term, with $1.2770 seen as resistance. A break of that level may push the euro/dollar toward $1.2950 and $1.30, analysts said.

Strategists at Citigroup said a close above $1.2490 in euro/dollar on Friday will "complete the bullish outside week" and a close above the 55-day moving average at 1.2550 will "confirm the bullish break."

"If achieved, these patterns would strongly suggest that the next significant directional move in euro/dollar will be up to $1.31," they wrote in a note.

Despite the potential for a near-term bounce, analysts remain bearish on the currency, saying the economic outlook for Europe remains fragile.

Three-month euro/dollar risk reversal was at -1.8 after the jobs data, according to Reuters data, from -1.85 before, with a bias to euro puts and dollar calls. A negative risk reversal shows greater demand for put options relative to calls or that put volatility is greater than call volatility, implying more investors are betting the currency will fall than rise.

Calls are options granting the right to buy an asset, and puts give the right to sell.

But volatility in three-month euro/dollar options fell to 13.61 percent on Friday after the data from 14 percent before the report. That indicates investors lowered their expectations for volatility in the single currency over the coming 90 days from prior to the jobs report.

Jack Iles, a portfolio manager at MFC Global Investment Management in Boston, expects the euro/dollar to trade in a range between $1.20 and $1.25.

"Until there's more clarity with respect to what's going on with the European banking community and stress tests, you'll see this type of (range-trading) action," he said. "If the euro spiked to $1.28, I would probably consider selling it."

Also next week, central banks in Australia, euro zone and UK are all scheduled to hold interest-rate meetings.

(Editing by Andrew Hay)

Source: Reuters