For the second day in a row, the U.S. dollar has appreciated significantly against the Euro and is also trading higher against the New Zealand dollar and Swiss Franc. However, the extent of today’s rally in the greenback basically ends there. The dollar is practically unchanged against the British pound and Australian dollars and is trading lower against the Canadian dollar and Japanese Yen. The 2.3 percent sell-off in U.S. equities coupled with the outperformance of the two lowest yielding G7 currencies indicates that risk aversion is the dominant theme. Yet, with no major U.S. economic data or market moving news over the past 48 hours, traders may be wondering, what changed. As recently as last week, investors were optimistic about a turnaround in the global economy following the more substantial outcome from the G20 meeting.

A bank report that we read this week had an interesting line summarizing investors’ attitude towards the U.S. dollar over the past few months. They said that being long dollars means being long pessimism and we believe that this is a valid description of the recent price action in the currency markets. Today, the dollar weakened against every major currency except for the Japanese Yen. This weakness as baffling as it may seem is more of reflection of the market’s optimism than pessimism because equities are higher and gold prices are lower.

With U.S. equities rising more than 5.5 percent today, one would expect the improvement in risk appetite to drive the U.S. dollar lower against all of the major currencies. Unfortunately we did not see a broad based sell-off in the U.S. dollar. The greenback only weakened against the Euro and commodity currencies because investors continued to bail out of British pounds and Swiss Francs. It is also interesting that the EUR/USD is well off its highs indicating that the market’s appetite for dollars has not waned dramatically. The catalysts for today’s rally are not convincing and the moves in the currency market are fizzling, which suggests that we have witnessed nothing more than a bear market rally.

On Friday, the Bureau of Labor Statistics is expected to tell us that US employers fired another 500k people in the month of January. Surprisingly enough currencies and equities are trading higher ahead of the non-farm payrolls report which suggests that traders are not afraid of a bad number. Everyone knows that the US economy is very weak and major job losses will continue. Since traders are becoming immune to bad data, it may take job losses in the area of 600k to spook them (January Non-Farm Payrolls Preview). Instead, traders are looking beyond Friday’s non-farm payrolls report to the Monday, February 9th speech by US Treasury Secretary Timothy Geithner. According to a Treasury official, Geithner is expected to unveil a bank rescue plan next week. This is one of the few things that could strike a meaningful recovery in the currency and equity markets. If traders deem Geithner’s plan as satisfactory, we could see a further recovery in the financial markets despite the fact that the US economy will get worse before it gets better.

The US dollar traded higher against the Euro and commodity currencies but remained unchanged against the British pound and Japanese Yen. The strength of the dollar can be attributed to three primary factors.