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From today's WSJ:

The belief that the Fed would be forced to sharply reduce interest rates to stimulate economic growth has weighed heavily on the dollar. That is because lower interest rates reduce returns on fixed-income holdings in the currency, making the dollar less attractive to investors.

Instead, investors are focusing on the possibility that further interest-rate cuts might not unfold as expected. Currency strategists say there is a strong belief the Fed will ultimately work to keep prices in line.

One recent challenge to the gloomy view on the economy came Thursday, when data showed retail sales in November were more resilient than predicted. The figures suggested "we don't really have a freefall in the U.S. economy," says Adnan Akant, a currency specialist at money manager Fischer Francis Trees & Watts. "It's slowing down but not falling out of bed."

Then on Friday, government data showed inflation last month was stronger than expected. That generated a fresh wave of dollar buying, pushing the greenback up about 1.4% against the euro in a day. Since late November, when the dollar weakened to a record low versus the euro, it has strengthened about 3%. Still, the dollar remains 8.5% weaker against the euro since the start of the year. Late Friday in New York, one euro fetched $1.4423.

The speed of Friday's move startled some investors. "Today has been kind of shocking for much of the market," said John Taylor, head of FX Concepts, a hedge fund that specializes in currency trading. Mr. Taylor says his firm has started shifting its positions from bets that the dollar will weaken to wagers that it will strengthen in coming weeks.

"One, the Fed is now scared of inflation, and two, the numbers keep looking pretty good," he says. The dollar "has shown more vigor than we thought."

Posted by edelfenbein at December 17, 2007 11:44 AM