By Tom Westbrook
LONDON (Reuters) – The dollar gave up some overnight gains against the yen on Wednesday as investors adjusted positions at the last minute before a policy meeting expected to kick off the U.S. monetary easing cycle.
The US Federal Reserve is expected to cut interest rates for the first time in more than four years at 1800 GMT, with markets pricing in a 61% chance of a 50 basis point rate cut.
The dollar has fallen with U.S. bond yields since July, reaching $1.1129 per euro, not far from its lowest level this year at $1.1201, amid expectations of a rapid pace of U.S. monetary policy easing, with more than 100 basis points of interest rate cuts priced in by Christmas.
The yen has risen more than 12% since July and is continuing to rise as the Bank of Japan, which sets policy on Friday, raises interest rates at the same time as the Federal Reserve prepares to cut them.
The Japanese currency rose about 0.4% to 141.80 against the dollar on Wednesday, recouping about a third of its overnight decline. The yen fell about 0.3% to 157.84 against the euro.
Elsewhere, the Australian dollar traded at a two-week high of $0.6778, while higher milk prices supported the New Zealand dollar at $0.62155, although the moves were tentative ahead of the Fed meeting.
“I think markets are having a hard time finding a clear direction today ahead of the FOMC meeting,” said Francisco Bisol, currency strategist at ING.
Traders say the Fed’s tone as well as the size of the rate cut will drive the reaction in the foreign exchange market.
“The Fed’s dovishness on a large easing path should weaken the dollar overall,” said Nathan Swami, head of currency trading at Citi in Singapore.
But Swami said an overly dovish Fed could end up spooking markets if it appears to be anticipating a more serious slowdown in the economy than expected, in which case risk-sensitive and emerging market currencies could face headwinds.
On the other hand, Bisoli said that the dollar will see a slight rise in the event of a 25 basis point interest rate cut.
But Bisol noted that “the move over the next few days and weeks toward the US jobs report will depend more on the press conference and the overall tone,” with markets remaining quite reluctant to return to long dollar positions or significantly reduce long dollar positions if the Fed signals it is open to a 50 basis point cut later in the year.
Data released last night showed that US retail sales unexpectedly rose by 0.1% in August, against expectations for a contraction of 0.2%, and the Atlanta Federal Reserve’s GDP estimate has now been raised to 3% from 2.5%, which could support the case for a smaller rate cut by the Fed.
Chinese markets resumed trading on Wednesday after the Mid-Autumn Festival holiday, with the yuan trading range holding at its strongest since January. The currency held steady at 7.0897 yuan per dollar. (CNY/)
Sterling, the best performing G10 currency this year, rose slightly to $1.3204, helped by signs of economic stabilization and stabilizing inflation. Official figures showed British inflation was at an annual rate of 2.2% in August, unchanged from July, but price growth in the services sector – closely watched by the Bank of England – accelerated.
Final European inflation figures are also due, but they are not expected to differ much from the preliminary figures for August, so all eyes will be on the Fed.
“With markets betting on a 41bp rate cut, which is still a far cry from either of the realistic candidates (25bp or 50bp), volatility seems all but guaranteed,” analysts at ANZ Bank said in a note to clients.
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