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Dollar Rallies against Euro and Pound due to risk aversion

Factory activity in the U.S. unexpectedly contracted in August to its lowest level in more than a year, a survey showed yesterday, heightening worries over the sustainability of the economic recovery. The Philadelphia Federal Reserve Bank said its business activity index fell to minus 7.7 in August versus an expected 7.0 reading this is down again from July’s plus 5.1. figure. The August reading was the lowest reading since the first contraction in July 2009.

Any reading below zero indicates a shrinking in the region’s manufacturing. “We see data like this and it kind of confirms the bottom end of the scenario and it’s going to be pretty tough all over right now for commodities, equities,” said Dan Cook at IG Markets in Chicago.

Yesterday morning’s advance jobless claims also discouraged investors who had been hoping to see claims fall below 450,000 instead of hitting their highest level for 10 months. Both these figures had an immediate impact on global risk appetite with traders initially buying Ten year T-notes and Dollar denominated assets. The pound lost ground away from its 1.5680 High and Euro/ Dollar dropped back almost 2 points to 1.2780 EUR/USD support.

The stock markets yesterday saw The Nasdaq Composite fall 1.8% to 2176. The S&P 500 fell 1.9% to 1074 and the Dow Jones fell 1.7% to 10239, weighed by a slide in Intel which dropped 3.4% after it agreed to pay $7.68 billion to acquire computer-security software maker McAfee, whose shares soared 57%.

The Dollar index which tracks the overall strength of the Green back against a basket of the most actively traded global currencies also spiked higher as bad data prompted a rush to the safety of the reserve currency. Oil also fell back to $75 per barrel as predicted consumption dropped.

European equities closed down yesterday with the FTSE dropping 1.64%, DAX down 1.69% and CAC minus 1.89%. The winner on the day was sterling which gained overall against the Euro by just over 0.4% to rest near resistance at 1.2200 GBP/EUR.

Although over the past few months we have seen a slight departure from the risk avert trend of buying the USD on bad data due to its safe-haven appeal, more recently and especially yesterday we saw a return to these risk adverse patterns, with risk aversion escalating dramatically this could set the tone for the medium term. When the U.S falters the dollar strengthens, oil drops off, bond prices rally and the stock markets fall. Risk aversion is again rife in the markets alongside some very positive German figures and retail sales figures from the UK. This could easily be a turning point as the markets decide whether to continue to back the Dollar as the reserve currency of choice or to diversify, only time will tell.