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FOREX-Dollar set for best week in three months, BoFA flags upside risk

* Graphic: World FX rates tmsnrt.rs/2RBWI5E

LONDON, Feb 5 (Reuters) - The dollar headed for its best weekly gain in three months on Friday, lifted by growing confidence that the U.S. economic recovery will outpace that of its global peers.

The dollar index touched a two-month high in Asian trade amid signs of resilience in the labour market, with closely watched U.S. nonfarm payroll figures due later. It retreated in European trading.

The dollar also renewed highs versus the euro and yen during Asian trade, although the euro recouped its losses in European trade.

While the dollar weakened significantly in 2020, it has strengthened since the start of this year, confounding some. Speculators still remain short dollars and consensus expects the dollar to weaken this year.

BoFA Global Research said there is a risk of upside dollar strength this year, given a more challenging outlook for risk assets.

“The recent market volatility following the GameStop saga has increased concerns that asset prices have deviated from fundamentals. In any case, starting the year with asset prices at record highs does not leave much room for further upside,” strategists at BoFA Global Research said in a note.

“With risk sentiment being the main FX market driver last year, a more challenging outlook for risk assets this year also suggests a less clear FX picture and upside USD risks.”

The dollar index touched 91.60 for the first time since Dec. 1, before drifting lower to 91.438 by 1158 GMT.

The gauge has risen every day this week and is on track for a 1.1% weekly advance, the most since Nov. 1, after a 0.3% rise the previous week.

The dollar has been supported by a rise in longer-term U.S. Treasury yields, which came as traders positioned for massive fiscal spending.

Democrats in the U.S. Senate were holding a marathon voting session aimed at overriding Republican opposition to President Joe Biden’s $1.9 trillion COVID-19 relief proposal.

Strategists at ING said a softening correlation of the dollar with equity markets was noticeable, though it was hard to account for. They noted that while U.S. Treasury yields have picked up in the past week, they have been matched by an equivalent rise in German bunds.

“And certainly, the US vaccination roll-out looks far more impressive than that in Europe, though year-to-date gains in the US S&P 500 (+3.08%) only marginally outpace those of the Eurostoxx 50 (+2.52%),” they said.

“Heavy short dollar positioning probably plays a big role here and would again seem vulnerable were any part of today’s non-farm payrolls jobs data to be greeted positively.”

Analysts and investors are weighing whether dollar strength this year is a temporary position adjustment after a 7% drop for the dollar index in 2020, or a longer-lasting shift away from dollar pessimism.

A lot of dollar shorts potentially need to be covered, particularly against the yen, where hedge funds had racked up their biggest bearish bets since 2016.

The dollar was 0.1% higher at 105.62 yen on Friday, earlier edging as high as 105.70 for the first time since Oct. 20.

The euro was 0.2% higher at $1.1980 after dipping to $1.1952, a level not seen since Dec. 1.

Reporting by Ritvik Carvalho; additional reporting by Kevin Buckland in Tokyo; editing by Larry King

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