* Dollar falls as stocks, commodities rally
* Investors square positions ahead of U.S. data
* U.S. jobs data key focus; ISM stronger than expected (Updates prices, adds quote, changes byline)
By Wanfeng Zhou
NEW YORK, Jan 4 (Reuters) - The U.S. dollar fell on Monday as broad gains in stock and commodity prices encouraged investors to seek riskier, higher-yielding investments at the expense of the greenback.
The dollar dropped also as traders locked in gains on its rally over the past month ahead of key U.S. jobs data on Friday which could dictate the currency's near term direction.
For much of 2008, the prospects of prolonged, low U.S. interest rates have spurred investors to buy high-yield assets funded by cheap borrowing in the dollar. While that pattern was interrupted before the year-end, analysts say the negative dollar-risk relationship is likely to reemerge.
"Risk was clearly back on for the first day of trading in the new year," said Michael Woolfolk, senior currency strategist at BNY Mellon in New York. "With risk back on, the negative correlation between the Dow and the U.S. dollar has also returned."
In afternoon trading, the euro
The single currency recovered from earlier falls, which took it as low as $1.4258, testing a key chart support level around $1.4229 where the 200-day moving average sits, and in sight of December's low around $1.4218.
A euro zone purchasing managers' survey, which confirmed the region's manufacturing sector expanded at its fastest rate in 21 months in December [ID:nLDE6030JH], also helped the euro against the dollar.
The ICE Futures' dollar index <.DXY>, a gauge of the greenback's performance against six other major currencies, fell 0.5 percent to 77.443.
Against the yen, the dollar traded down 0.5 percent at
92.50 yen
Optimism about the prospects for a U.S. recovery has supported the dollar in December but analysts said more evidence of a strengthening economy was needed to justify further gains.
The dollar has moved mostly higher since figures early last month showed the U.S. economy shed a far fewer-than-expected 11,000 jobs in November.
For December payrolls, the median forecast of analysts polled by Reuters is for a decline of 8,000. However, the predictions ranged widely, from a loss of 80,000 jobs to an increase of 59,000. [ECI/US]
Some economists think December marked the first month in two years that there were more jobs created than eliminated. Any sign of jobs growth raises expectations the U.S. Federal Reserve will hike interest rates sooner rather than later -- a move that would boost dollar-based assets.
"The implications of positive job growth, regardless of whether it is a few hundred or a few thousand jobs, should help to drive the dollar higher," said Kathy Lien, director of currency research at GFT in New York.
A report from the Institute for Supply Management showing the U.S. manufacturing sector expanded in December for a fifth straight month briefly helped the dollar trim its losses against the euro. [ID:nN04236157].
Commodity currencies rose on higher oil and gold prices.
The Australian dollar surged 1.8 percent to US$0.9131