Dollar Strengthens as Federal Reserve May Signal Stimulus Exit

By Anchalee Worrachate and Ron Harui
Sept. 21 (Bloomberg) -- The dollar rose to a one-week high against the yen and climbed versus the euro on speculation U.S.
policy makers will this week signal they may withdraw economic stimulus measures, boosting the appeal of the nation’s assets.
The dollar advanced to a two-week high against the pound and strengthened versus 13 of the 16 major currencies before a report that economists said will show an index of U.S. leading indicators gained for a fifth month, backing the case for the Federal Reserve to wean the economy off support. The difference in yield between 10-year Treasuries and comparable Japanese government bonds, known as JGBs, widened to 212 basis points from 207 basis points at the start of the month.
"Investors are keen to see to what extent the Fed will acknowledge the improvement in the recent economic data and the market might be positioning for that," said Henrik Gullberg, a currency strategist in London at Deutsche Bank AG. "The yield spread between the Treasuries and JGBs has widened, and that tends to be supportive of the U.S. currency as well."
The dollar rose to 92.02 yen as of 8:51 a.m. in London, from 91.29 yen in New York on Sept. 18, after earlier reaching
92.19 yen, the highest level since Sept. 10. It strengthened to
$1.4653 per euro, from $1.4712. The U.S. currency advanced to
$1.6179 versus the pound, from $1.6271, after earlier touching $1.6135, the most since Sept. 2.
The yen fell to as low as 135.18 per euro, the weakest level since Aug. 25, before trading at 134.90, from 134.33 last week. Japan’s currency declined 0.3 percent to 79.38 versus Australia’s dollar.

Dollar Index

The Dollar Index, which the ICE uses to track the dollar against the currencies of six major U.S. trading partners, rose
0.5 percent to 76.839. It’s fallen 5.5 percent this year.
The Fed will keep its target rate for overnight loans in a range of zero to 0.25 percent at its two-day policy meeting starting tomorrow, according to all 91 economists surveyed by Bloomberg News. Chairman Ben S. Bernanke said in Washington on Sept. 15 that the worst U.S. recession since the 1930s has probably ended.
"That’s why there might be a little bit of nervousness going into the FOMC if they start signaling any potential unwind of quantitative easing," Tony Morriss, senior markets strategist in Sydney at Australia & New Zealand Banking Group Ltd., said in a Bloomberg Television interview. "There is a bit of risk over the next couple of days of the dollar starting to recover a little bit of ground."
The Conference Board’s gauge of the U.S. economic outlook for the next three to six months rose 0.7 percent in August, after a 0.6 percent gain in July, a Bloomberg survey showed before the New York-based group releases the report today.

Yen to Weaken

The world’s biggest banks say the Japanese currency is likely to weaken.
While the yen gained against all but one of the 16 most- actively traded currencies since early August as the Democratic Party of Japan became the likely winner in national elections, forecasters say it will decline 5.7 percent against the dollar and 1.2 percent versus the euro by year-end. The economy is too weak to support a stronger rate, based on the median estimate in a Bloomberg survey.
Japan will be the only Group-of-10 nation that won’t raise borrowing costs in 2010, keeping its benchmark interest rate at a record low 0.1 percent, the survey showed. The economy will expand 0.8 percent next year after contracting 6 percent in 2009, according to median forecasts, putting assets in the world’s second-biggest economy at a disadvantage to those in countries with higher borrowing costs.

‘Deteriorated Significantly’

"Everyone is seemingly buying the yen, which I think is ridiculous," said Jim O’Neill, head of global economic research at Goldman Sachs Group Inc. in London. "The true underlying fundamentals for the yen in my book have deteriorated significantly."
New York-based Goldman Sachs, which earned more than $100 million from trading for a record 46 days last quarter, predicts the yen will weaken to 98 per dollar and 142 per euro by the end of the year.
The pound may weaken further against the dollar and the euro on speculation the Bank of England will keep borrowing costs low, according to BNP Paribas SA.
BOE Governor Mervyn King last week told lawmakers in London that cutting the deposit rate paid to financial institutions is "something we’re looking at." Banks are currently paid 0.5 percent on the deposits. While the U.K. central bank is boosting its reserves by buying 175 billion pounds of bonds through so- called quantitative easing, King said he doesn’t want it to go too far.

‘Will Be Hit’

"Sterling will be hit by the BOE keeping interest rates low, continuing to purchase gilts in the open market via an expansion of its balance sheet," analysts led by Hans-Guenter Redeker, London-based global head of currency strategy at BNP Paribas, wrote in a research note dated yesterday. "We have revised our pound projections lower."
BNP now expects the pound to decline to $1.57 by the end of this year, compared with $1.53 previously. The French bank also forecasts the pound to fall to 98 pence per euro by year-end, versus a prior prediction of 88 pence.
The pound dropped to 90.70 pence per euro from 90.40 pence on Sept. 18, after earlier touching 90.78 pence, the lowest level since Apr. 24.