Dollar wallows near 7-month low after Fed's surprise nod to doves

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US dollar languishes near a seven-month low against a basket of major currencies after the Federal Reserve wrong footed many investors. US dollar languishes near a seven-month low against a basket of major currencies after the Federal Reserve wrong footed many investors.
SummaryEuro clings near 7-1/2 mth high, Yen slips as risky assets rally.

The dollar languished near a seven-month low against a basket of major currencies on Thursday after the Federal Reserve wrong footed many investors who had positioned for a scaling back in its massive stimulus program.

The dollar index slid 1.2 per cent overnight, its biggest one-day slide in more than 2 months, after the Fed maintained its $85 billion monthly asset-buying programme, confounding expectations of a reduction by roughly $10 billion.

It has fallen to levels seen well before Fed Chief Ben Bernanke first floated the idea of tapering the stimulus back in May.

The dollar index last stood at 80.215, after having fallen to 80.060 on Wednesday, its lowest level since February.

Emerging Asian currencies, which had taken a battering in recent months on concerns a Fed stimulus cut would trigger an exodus of capital, rallied hard, with some Southeast Asian units surging around 2 per cent.

"The Committee had underestimated the impact on longer-term rates and is now trying to get the genie back in the bottle," said Philip Marey, senior U.S. strategist at Rabobank.

Indeed, Fed Chairman Ben Bernanke refused to commit to begin reducing the bond purchases this year. As well, the central bank cut its growth forecasts for 2013 and 2014, citing strains in the economy from tight fiscal policy and higher mortgage rates.

The surprise decision saw U.S. Treasury yields tumble while riskier assets, particularly emerging markets, staged a barnstorming rally.

U.S. benchmark 10-year yields dropped to a one-month low of 2.673 per cent on Wednesday, well off highs around 3.01 per cent set earlier in the month. The 10-year Treasury yield last stood at about 2.697 per cent.

The rally in riskier assets weighed on the safe haven yen, and helped the dollar regain some ground versus the Japanese currency.

The dollar rose 0.5 per cent to about 98.48 yen, pulling away from Wednesday's three-week low of 97.76 yen

Mitul Kotecha, head of global foreign exchange strategy for Credit Agricole in Hong Kong, said the dollar's moves versus the yen were being influenced by two conflicting factors, the drop in U.S. bond yields on the one hand and a bounce in risk appetite on the other.

"In a way dollar/yen is conflicted, it's in a battle between these two factors," Kotecha said.

"The Fed is clearly trying to cap U.S. yields, and I think from that perspective dollar/yen may struggle to push higher in the short term," he added.

The euro held steady at $1.3526, clinging near Wednesday's post-Fed high of $1.3543, which was the single currency's highest level since early February.

Higher-yielding currencies also fared well. The New Zealand dollar climbed 0.6 per cent on the day to $0.8393. It set a four-month high of $0.8414 earlier on Thursday, getting an added lift after data showed New Zealand's economy grew at a better-than-expected pace in the second quarter.

The Australian dollar eased 0.1 per cent to $0.9491, holding near a three-month high of $0.9530 set on Wednesday.

But once the dust settles, traders said markets will no doubt start to speculate on when the Fed will begin to taper its stimulus, giving the dollar a bit of support.

There are only two more scheduled policy meetings this year, one in October and one in December.

Barclays Capital analysts now believe the Fed will begin to taper in December and they expect the Fed to end its asset purchase programme in June 2014, three months later than their previous prediction.

"The delay in unwinding the asset purchase program also leads us to delay our expectation of the first rate hike; we now expect that in June 2015, later than our previous expectation of March 2015," they wrote in a note.

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