LONDON (Dow Jones)--The dollar's glass is starting to look half full rather than half empty.
The U.S. currency's performance over the last day or two suggests that evidence of an economic recovery may finally be restoring investors' faith.
Until now, the */focus/* <#Term1> of their attention appeared to be the continued deterioration in the U.S. housing market as well as fears of further losses at U.S. banks.
"There have been a growing number of people in the market who are willing to believe that the end of the worst for financials is in sight," said Lena Komileva, G8 economist with international broker Tullett Prebon in London.
Hans Redeker, head of global foreign exchange strategy at BNP Paribas in London, said that greater confidence in the U.S. is also evident in a rise in foreign direct investment flows.
"Overall there has been a massive increase in the amount of dollar-positive M&A deals announced over the past two months," he said.
Redeker reported that his bank's euro/dollar FDI flow indicator "shows that these long-term flows have not only turned the euro/dollar outlook bearish but represent the biggest net inflow to the dollar since the dot.com bubble of the late 1990s."
"The extent of the longer term inflows to the U.S. suggests that international investors have a high level of confidence in the U.S. economy," he added.
Much of the improved sentiment this week may also have been driven by the continued slide in crude oil prices. They are now well below $130 a barrel after reaching a recent record high of $147 a barrel.
"It would seem that the risk of shorting the dollar may now be at the highest level since oil first broke the $100 marker at the start of the year - risks that can only grow if oil remains on its present course," said Neil Mellor, senior currency strategist with Bank of New York Mellon in London.
However, it's optimism that the slowdown in the U.S. is coming to an end and the U.S. Federal Reserve may soon start contemplating hikes, rather than further cuts, in interest rates that's largely helping to push up the dollar.
Over the last week or two, regional Federal Reserve officials, rather than Fed Chairman Ben Bernanke himself, have increased their warnings about growing price pressures and made it clear that tighter policy may be needed soon to prevent inflation from becoming entrenched.
Tullet Prebon's Komileva noted that with real inflation-adjusted rates now down at -3%, these warnings from Fed officials aren't surprising.
"The question is not if the Fed will start raising interest rates, but when," Komileva said.
This increase in rate hike expectations has come despite the continued rollcall of U.S. bank losses as the impact of the credit crunch continues to hit their balance sheets.
However, for all the losses announced by smaller institutions this week, such as American Express and Wachovia, there are better-than-expected results coming the largest banks in the country, such as Citigroup, JP Morgan Chase, Bank of America and Wells Fargo.
Komileva sees this as enough to keep the engines of recovery on the go.
"Increased differentiation in equities would be expected to pave the way to increased M&A activity once broad macro-financing conditions improve, which would in turn support market liquidity, fueling a recovery," she said.
With global equity markets once again on the rise, risk appetite has shown a strong recovery, with the UBS Risk Aversion Index falling to its lowest level in two months Wednesday.
But some analysts remain unconvinced that a turnaround in the dollar's fortunes is here just yet.
At UBS, Geoffrey Yu, a senior currency strategist with the bank in Zurich, said he's still cautious of "chasing the dollar higher at present."
"But," he added, "if the earnings season concludes without incident and key euro zone data continue to deteriorate, the euro/dollar may turn decisively."
The strategy team at Commerzbank is also holding back, saying that the dollar remains "fragile" and that more negative news from the U.S. economy is coming weeks will ensure that the euro retests $1.60.
Nevertheless, dollar bulls point out that apart from fundamentals, technical factors could also work in the dollar's favor.
In the case of oil prices, there appears to be growing downside momentum that's expected to increase if the price falls below May's consolidation levels at $124 a barrel, said Bank of New York's Mellor.
And as far as the dollar's performance against the yen is concerned, the pair has now closed above a 200-day moving average, ensuring that the dollar is better placed to make further gains against its Japanese counterpart.
Early Thursday in Europe, the dollar remained supported by falling oil prices and higher equities markets, with the Nikkei gaining 2.2%.
The U.S. currency rose to Y107.87 from Y107.85 late Wednesday in New York, according to EBS.
Attention will turn to the closely watched German Ifo business sentiment index, due at 0800 GMT, with expectations of a further decline to 100.2 from last month's reading of 101.3.
The euro was marginally weaker at $1.5684 from $1.5690 late in New York Wednesday, while the single currency traded at Y169.17 from Y169.25.