The dollar hit new highs against the yen and the euro on Wednesday, but eased back from the session’s best levels as equity markets fell and central banks were seen buying the euro.
The initial strength of the US currency was driven by comments from Federal Reserve officials on Tuesday. Janet Yellen, president of the San Francisco Fed, said the current 3.75 per cent level of the Fed funds rate was at the lower end of her estimate of a neutral policy.
“Over the years listening to Janet Yellen has proven to be sound dollar policy and now that she has stated that neutral is between 3.5 per cent and 5.5 per cent, which is well above consensus, the dollar may be enjoying the interest-rate premium for some time to come,” strategists at Investors Bank & Trust said.
But with little newsflow, the possible impact of yet higher interest rates on US growth weighed on currency investors’ minds. Its toll on equity markets, seen by some as a negative for the greenback, added to the downward swing for the dollar.
“Economically, high interest rates are a doubled-edged sword for the US economy. On the one hand it is good for interest rate differentials, but on the other hand it is bad for US asset markets and US growth,” said Julian Jessop of Barclays Capital. “It may be people are getting a bit nervous about the outlook for the US economy if the Fed raises rates too aggressively.”
The dollar hit a two-year high against the yen at Y116 but later slid 0.3 per cent to Y115.49, while the euro climbed from a 3-month low of $1.1876 versus the greenback all the way up to $1.20. At midday in New York the dollar traded down 0.5 per cent at $1.1984.
“Because the speculative funds are neutral towards the euro/dollar at the moment, the very short term players are flipping their positions back and forth very quickly and that’s making the euro/dollar quite volatile today,” Paul Mackel of ABN Amro said. He added despite the euro’s recovery he was still biased towards single currency weakness going forward.
Two factors helped the euro rebound. Otmar Issing, European Central Bank chief economist, highlighted how important it was that the market believed inflation would be cut to below the ECB’s price stability level of 2 per cent. This reinforced the belief the bank may raise interest rates, possibly before the end of the year.
Also, there was a “big pocket of liquidity” on the euro’s dip below $1.19. Market speculation pointed to Middle Eastern and Asian central banks, seeking to diversify their currency reserves, buying the euro.
A perceived lower likelihood of rate cuts in the UK buoyed the pound. The Bank of England’s rate setting committee was unanimous in its decision earlier this month to hold UK interest rates at 4.5 per cent. The minutes of the meeting, released on Wednesday, showed that arguments for a rate cut had not even been discussed.
“We think it is premature to completely rule out an interest rate cut in November,” Howard Archer of Global Insight said.
But he added: “It is entirely possible that the monetary policy committee could remain on the sidelines in November, but hint that a further interest rate cut could occur by early new year if growth remains muted and underlying inflationary pressures show signs of abating.”
Sterling strengthened 0.8 per cent to $1.7622 against the greenback, having slid to $1.7429 at one point, its lowest level since July. The pound climbed 0.4 per cent versus the euro to £0.6801.
The Thai baht eased 0.2 per cent to Bt40.94 after the country’s central bank raised interest rates by 50 basis points to 3.75 per cent. The market had factored in an increase but not by as much.
The Bank of Thailand has now raised interest rates eight times since august 2004, a total of 2.5 percentage points to rein in inflation. This was the second half point rise in six weeks and came after inflation hit 6 per cent, its highest since 1998, in September.
The accompanying statement by the central bank was viewed as hawkish and the currency was expected to recover in coming days now rates are on a par with the US.
Weakness in Asian stock markets led investors to shed the region’s currencies in favour of the dollar.
Foreign investors were net sellers of Taiwanese stocks for the sixth straight session and net sellers of South Korean shares for the 19th consecutive session.
The Taiwan dollar fell 0.2 per cent to T$33.638 versus the dollar, having hit T$33.724, its lowest in nearly a year. The South Korean won dipped 0.3 per cent to Won1,054.4 having hit a three month low of Won1,055.40.
Chinese academics said the country should switch some of its vast $769bn of currency reserves out of the dollar. In the study reported in a paper backed by the People’s Bank of China, Shi Jianping, head of the finance school at the Central University of Finance and Economics also suggested forex reserves should be invested in strategic resource reserves such as petroleum and other mineral products, as well as supporting overseas investment and purchases by Chinese enterprises.
The rapid growth of reserves, up nearly 50 per cent year-on-year added to appreciation pressure on the renminbi, Mr Shi said.
