Dollar extends early losses after downbeat ISM data

Greenback plunges against yen; Fed minutes, crude-oil spike add pressure

By Lisa Twaronite, MarketWatch

Last update: 2:23 p.m. EST Jan. 2, 2008

SAN FRANCISCO (MarketWatch) -- The dollar extended losses against most major rivals Wednesday, plunging against the yen after the Institute of Supply Management said the U.S. factory sector contracted in December, crude-oil futures hit $100 a barrel for the first time and minutes from the Federal Reserve's last meeting showed little opposition to an interest rate cut.

Nearly all members of the Federal Open Market Committee backed the quarter percentage-point cut in the federal funds rate at the Dec. 11 meeting, though the minutes provided little guidance about what the FOMC might do at the Jan. 29 and 30 meeting. Read The Fed.

Lower interest rates weigh on the dollar because they reduce the return on dollar-denominated assets.

Earlier Wednesday, crude for February delivery rallied $4.02 to $100 a barrel on the New York Mercantile Exchange, on expectations U.S. crude inventories may have fallen for a seventh straight week and concerns about violence in Nigeria, Africa's biggest crude producer.

Oil's standard trading unit is dollars per barrel. As the dollar drops, so does the price of oil in non-dollar terms. This usually encourages investors who hold other currencies to bid up the price of oil, leading it to rise in dollar terms.

A report released n the morning session showed the ISM index fell to 47.7% from 50.8% in November. Economists expected the index to slide to 50.5%. Readings below 50% indicate more manufacturing firms were contracting than were growing in December. It was the lowest reading since April 2003 and the first sub-50 reading since January 2007. See Economic Report.

"Today's [ISM] release is definitely unsettling," wrote Stephen Stanley, Chief Economist at RBS Greenwich Capital.

"The real question is whether today's data point to a brief pause in activity or a more persistent trend. It is always tough to make that call when faced with one outlier downside reading. We are inclined to wait a month and see what the January figures look like before tossing the manufacturing sector onto the trash heap," he added.

U.S. stocks were sharply lower Wednesday, after the ISM report and crude-oil price spike. See Market Snapshot.

Yen surges

The stock market downturn lifted the yen, which tends to weaken as investor's appetite for risk increases and they take on so-called carry trade positions, in which investors borrow funds in yen at low rates to invest in other higher-yielding assets.

The dollar was buying 109.47 yen, down about 2.2%, compared with 111.02 yen earlier.

The euro was at $1.4732, up about 0.8%, compared with $1.4652 earlier.

The dollar managed to hold onto some gains against the British pound sterling, which was down about 0.3% at $1.9821, but still up from $1.9783 earlier.

The dollar index, which measures the greenback against a basket of six major currencies, was down about 0.8% at 75.940, compared with 76.390 earlier Wednesday.

Currency investors largely shrugged better-than-expected construction data.

Commerce Department data showed spending on construction projects hit a two-month high in November, rising by 0.1% on strong outlays for public, state and local construction projects. Economists surveyed by MarketWatch had been expecting construction spending to fall by 0.5% in November.

Spending on home construction, meanwhile, continued its slide, falling by 2.5% in November following a drop of 2.3% in October. It's the 21st consecutive decline. See Economic Report.

Later Wednesday, the Federal Reserve is scheduled to release the minutes of its Dec. 11 meeting, at which the central bank cut rates by a quarter-point to 4.25%.

Yuan starts on high note

In Asian trading Wednesday, the Chinese yuan kicked off the new year with a new record high close against the dollar over-the-counter trading. The yuan rose to 7.2934 against the dollar, up from Friday's 7.3041 close. Chinese markets were closed Monday.

The yuan gained nearly 7% in 2007, with over 2% of the gains coming in the last two months of 2007.

In its tightly-controlled currency markets, China permits the yuan to trade in a band of 0.5% on either side of its official parity rate, which it sets daily.

Chinese officials have indicated that the yuan will be allowed to gradually appreciate in the country's tightly controlled foreign-exchange market, to help alleviate domestic inflationary pressures.