The dollar pushed higher on Tuesday revealing strong foreign demand for US financial assets assuaged fears that the US will struggle to fund its ballooning trade deficit.
With structural worries receding, the market was able to focus on dollar-positive cyclical factors such as the strong growth and interest outlook for the US.
Net portfolio inflows totalled $81bn in November, well above the expected $55bn and even that month's record trade deficit of £60.3bn. "There is no absence of foreign appetite for US assets at this moment," said Michael Woolfolk, senior currency strategist at Bank of New York.
However, the dollar's rally in the wake of the data was somewhat muted, with several commentators pointing to disappointing detail.
Foreign buying of US equities leapt to $14.5bn in November, the strongest figure since May 2001. But the market had been expecting a strong figure as political risk fell in the wake of the US presidential election in early November, allowing Wall Street to rally. Indeed, US buying of foreign equities was stronger still, at $16.1bn, an important factor with cross-border equity purchases unlikely to be hedged.
The data also threw up further hints that the People's Bank of China may be re-balancing its reserves by directing a smaller proportion of its new money into the dollar.
While Chinese forex reserves rose by $31.4bn in November, China only bought $7.95bn of Treasuries. The figures could be a sign of diversification away from the dollar, or, less excitingly, the result of China keeping more of its money in deposit instead. Mr Woolfolk also noted a spike in buying by offshore Caribbean centres, possibly using re-routed Chinese money.
Nevertheless, the return of cyclical factors to the dollar equation is leading some analysts to question the market mantra of further dollar weakness ahead, in the short term at least.
Calyon on Tuesday forecast that euro-dollar will end 2005 at $1.25. "Our view of equity outperformance versus bonds, strengthening interest rate expectations in the US versus the eurozone and superior economic performance in the US point to some dollar recovery during the remainder of 2005," said Mitul Kotecha, global head of FX strategy.
With this backdrop, the dollar firmed 0.2 per cent to $1.3042 to the euro, having hit a near two-month high of $1.2996, and 0.2 per cent to Y102.42 against the yen, bouncing off Monday's five-year low of Y101.68.
Sterling spiked higher as a surprise rise in UK inflation led to renewed expectations of one more interest rate rise. Consumer inflation edged up to 1.6 per cent in the year to December, from 1.5 per cent a month earlier, bucking expectations of a slide to 1.4 per cent amid falling petrol prices and high-street discounting.
The sterling-positive mood was strengthened by the Royal Institution of Chartered Surveyors, which said the balance of estate agents reporting a rise in UK house prices, minus those reporting a drop, rose to -37 per cent in December, from a record low of -48 per cent a month earlier.
This allowed sterling to rise 0.5 per cent to $1.8680 against the dollar, 0.7 per cent to £0.6977 against the euro and 0.8 per cent to Y192.24 versus the yen.
The yen was generally weak, with Derek Halpenny, senior currency economist at Bank of Tokyo-Mitsubishi, citing short-covering by speculators, as well as Japanese importers buying dollars. Renewed oil price strength also weighed on the yen, with Paul Mackel, currencies strategist at ABN Amro, seeing this same factor buoying both sterling and the Norwegian krone, which rose 0.5 per cent to a six-week high of NKr8.1585 to the euro.
