Dollar falls as risk appetite rises

Traders in the Eurodollar options pit at the Chicago Board of Trade signal orders, shortly after the Federal Reserve's decision to leave short-term interest rates untouched between zero and 0.25 percent, in Chicago December 16, 2009.

NEW YORK (Reuters) - The U.S. dollar fell on Monday as optimism about a global economic recovery encouraged investors to seek riskier investments such as stocks and commodities at the expense of the greenback.

The dollar dropped also as traders locked in gains on its rally over the past month ahead of key U.S. jobs data on Friday which could dictate the currency's near term direction.

Chinese manufacturing grew at its fastest pace on record in December, while U.S. factories marked their best month in nearly four years, data showed on Monday, boosting confidence in the global economy.

"Risk was clearly back on for the first day of trading in the new year," said Michael Woolfolk, senior currency strategist at BNY Mellon in New York.

"We're likely to see the very strong negative correlations come back again during the first half of (2010) as the Fed maintains its zero interest rate policy, which encourages using the dollar as a funding currency," he added.

The prospects of prolonged, low U.S. interest rates have spurred investors to buy high-yield assets funded by cheap borrowing in the dollar for much of the past year, leading to a negative correlation between the greenback and risky trades.

While that pattern was interrupted before the year-end, analysts say the negative dollar-stock link is likely to continue to drive currency trading in the coming months.

In late trading, the euro was up 0.6 percent against the dollar at $1.4409. The single currency recovered from earlier falls, which took it as low as $1.4258, testing a key chart support level around $1.4229 where the 200-day moving average sits, and in sight of December's low around $1.4218.

A euro zone purchasing managers' survey, which confirmed the region's manufacturing sector expanded at its fastest rate in 21 months in December, also helped the euro against the dollar.

The ICE Futures' dollar index .DXY, a gauge of the greenback's performance against six other major currencies, fell 0.4 percent to 77.516.

Against the yen, the dollar traded down 0.5 percent at 92.57 yen, giving up gains which lifted it to a four-month high of 93.21 yen. Traders said resistance was seen ahead of its 200-day moving average around 93.60 yen.

JOBS DATA

A report from the Institute for Supply Management showing the U.S. manufacturing sector expanded in December for a fifth straight month briefly helped the dollar trim its losses against the euro.

Optimism about a U.S. recovery has supported the dollar in December, but analysts said more evidence of a strengthening economy was needed to justify further gains.

For December payrolls, the median forecast of analysts polled by Reuters is for a decline of 8,000. However, the predictions ranged widely, from a loss of 80,000 jobs to an increase of 59,000.

Some economists think December marked the first month in two years that there were more jobs created than eliminated. Any sign of jobs growth raises expectations the U.S. Federal Reserve will hike interest rates sooner rather than later -- a move that would boost dollar-based assets.

"The implications of positive job growth, regardless of whether it is a few hundred or a few thousand jobs, should help to drive the dollar higher," said Kathy Lien, director of currency research at GFT in New York.

Commodity currencies rose on higher oil and gold prices. The Australian dollar surged 1.7 percent to US$0.9123, while the Canadian dollar rallied, pushing the greenback 1 percent lower at C$1.0416.

(Additional reporting by Gertrude Chavez-Dreyfuss; Editing by Chizu Nomiyama)