FX OUTLOOK-Dollar likely rangebound amid summer slumber

By Steven C. Johnson

NEW YORK, July 2 (Reuters) - Uncertainty about the strength of the world economy and concern about the U.S. fiscal deficit will probably confine the dollar to a narrow trading range next week as markets ease into the typically quiet summer doldrums.

Until now, the dollar has held up fairly well despite a swelling deficit, an onslaught of government debt issuance and repeated calls to end its status as global reserve currency.

That's partly because recent economic data has tempered the optimism that had prompted investors to pull out of safe-haven U.S. assets in favor of commodities, stocks and higher-yielding currencies. Data on Friday showed U.S. employers cut 467,000 jobs in June, far more than economists were expecting after May's surprisingly low tally of 322,000 job losses.

"If you were banking on the U.S. driving a vigorous recovery, think again," said Alan Ruskin, chief international strategist at RBS Securities in Greenwich, Connecticut.

The dollar's gains on Friday remained modest, however, with the euro holding firm around $1.40, despite a looming three-day U.S. holiday weekend that would typically prompt investors to reduce exposure to risk.

Financial markets in Europe and Asia are open on Friday.

Also, other economic indicators, including manufacturing gauges from the United States, China and Europe, have shown slow but steady improvement.

"The market is still favoring foreign currencies over the dollar," said Meg Browne, senior currency strategist at Brown Brothers Harriman in New York. "Sentiment still says to sell the dollar whenever possible."

Hidetoshi Yanagihara, senior currency trader at Mizuho Corporate Bank, said, "there are scarcely any incentives to buy dollars, yen or euros," adding that the economic outlook for Japan and the euro zone also remain far from stellar.

That should leave the dollar rangebound against the yen, "without any clear sense of direction," while the euro is likely to continue to hover in the $1.37-$1.43 area. The dollar has held roughly between 94 and 99 yen since early May.

POTENTIAL DOLLAR PITFALLS

The greenback does face some downside risks, though. With a light U.S. economic data calendar -- service sector activity on Monday and international trade data on Friday are the highlights -- currency investors may focus instead, to the dollar's detriment, on the U.S. fiscal deficit and inflation.

The Federal Reserve has cut short-term interest rates to zero and has tried to cap long-term rates as well by printing money to buy government debt, raising inflation worries in some quarters.

"Uncertainty (about) the end-game....and potential policy mistakes are a dollar negative," wrote Morgan Stanley currency strategists in a research note.

What's more, China and Russia, among the biggest holders of U.S. Treasury debt, repeatedly have raised concern about the dollar and called for talks on replacing it as global reserve currency. Sources told Reuters recently the issue would be raised at next week's Group of Eight meeting in Italy.

That's another negative for the dollar, particularly when the Treasury says it expects to issue $2 trillion in debt this year. Auctions for $65 billion in 10- and 30-year debt, which tends to hold less appeal for foreigners, are due next week.

Conviction has been hard to come by among currency traders, though. Browne notes that recent U.S. debt auctions have gone swimmingly despite inflation worries and the dollar concerns expressed in places like Beijing and Moscow.

And the market is still not ready to render a verdict on just how robust any global recovery will be.

As the summer wears on, however, the dollar may see renewed safe-haven buying, warns Dan Cook, senior currency strategist at IG Markets in Chicago.

"I think banks will start coming out with second-quarter earnings that are well below expectations. That's going to bring some risk aversion back into the market," he said. (Editing by Andrea Ricci)