Monday, January 14, 2008

Dollar Falls to Within a Cent of Euro Record on Bets Fed to Cut

By Bo Nielsen and Ye Xie

Jan. 14 (Bloomberg) -- The dollar fell to within a cent of its all-time low versus the euro on speculation U.S. interest rates will drop below those of the 15 nations that share the single European currency for the first time in three years.

The U.S. currency extended three weeks of declines as Federal Reserve officials including Chairman Ben S. Bernanke signaled last week they favor greater ``insurance'' against an economic slowdown amid the slump in the housing market. European Central Bank council member Klaus Liebscher said today he sees ``significant'' upside risks to inflation.

``Interest rates in the U.S. are falling below those in Europe,'' said David Watt, a senior currency strategist at RBC Capital Markets Inc. in Toronto, a unit of Canada's biggest bank by assets. ``There are few reasons to buy the dollar.''

The dollar fell to as low as $1.4915 against the euro, the weakest since declining to a record low of $1.4967 on Nov. 23, and traded at $1.4870 as of 4:02 p.m. in New York, from $1.4776 on Jan. 11. It depreciated to the lowest since Nov. 27 against the yen, trading as low as 107.37 yen, before rebounding to 108.19. Watt said the dollar could weaken to $1.50 per euro this week.

The euro was little changed against the yen at 160.89, from 160.79 on Jan. 11.

Dollar's Decline

The U.S. Dollar Index traded on ICE Futures in New York, which tracks the dollar against six major currencies, touched 75.361, the lowest since Nov. 29. The index fell to 74.484 on Nov. 23, the weakest since the gauge started trading in 1973.

The U.S. currency may fall to $1.55 per euro by the end of the first quarter, London-based Bilal Hafeez, global head of currency strategy at Deutsche Bank AG, the world's largest foreign-currency trader, said in an interview. That compares with a median forecast of $1.47, compiled by Bloomberg from reports by 47 strategists and economists.

The Fed has lowered benchmark borrowing costs by 1 percentage point to 4.25 percent since September while the ECB has increased rates eight times to 4 percent since November 2005. The ECB kept rates unchanged on Jan 10. The euro has risen 15 percent in the past 12 months against the dollar.

Fed funds futures contracts on the Chicago Board of Trade show 52 percent odds the Fed will cut its target rate for overnight bank loans to 3.75 percent at its Jan. 30 meeting. The odds have risen from no chance a month ago. The odds of a decrease to 3.5 percent are 48 percent, compared with zero a week ago.

Yield Spread

The yield spread between German two-year notes and same- maturity Treasuries was 1.13 percentage points, near the widest since November 2002. The ECB is under pressure to keep interest rates unchanged even as inflation of 3.1 percent last month was above its 2 percent ceiling.

Investment banks including UBS AG, the world's second- biggest currency trader, and New York-based Goldman Sachs Group Inc. cut their dollar forecasts last week.

The euro strengthened after reaching a record against the currencies of the region's 24 biggest trading partners. It advanced against all but six of the 16 most-active currencies today. The single currency also climbed to a record 76.08 British pence and was recently at 76 pence, from 75.52 pence on Jan. 11.

The pound declined against 15 of the 16 major currencies even as a report showed U.K. factories increased prices at the fastest annual pace since 1991 in December.

Bank of England

Traders bet the Bank of England will cut interest rates from 5.5 percent to 4.75 percent by September, according to the September 90-day sterling interest-rate futures traded in London. The contract yielded 4.74 percent today, down from 5 percent on Dec. 31.

The common European currency extended gains against the dollar after rising beyond $1.4825 and $1.4850, where orders to buy the euro were placed, said Michael Woolfolk, senior currency strategist at the Bank of New York Mellon in New York, the world's largest custodial bank with over $20 trillion in assets under administration. Traders sometimes use automatic instructions to limit losses in case bets go the wrong way.

``Some suggested that it was an Asian trade based on the rumor that the Fed will do an inter-meeting cut today,'' Woolfolk said. ``The expectations of the Fed's interest-rate cuts are undermining the dollar.''

The dollar fell against all 16 most-active currencies before a Commerce Department report economists in a Bloomberg News survey say will show retail sales were unchanged in December. The data will be released tomorrow.

Swiss Franc

The Swiss franc rose to a record against the dollar and the strongest in five months versus the euro as the risk of European companies defaulting on their debt rose, prompting investors to unwind carry trades. The franc gained to as high as 1.0886 per dollar.

``Traders are expecting this week's data to be pretty weak, supporting much more aggressive actions from the Fed,'' said Kathy Lien, chief currency strategist at in New York.

The Fed is ``ready to take substantive additional action as needed to support growth and to provide adequate insurance against downside risks,'' Bernanke told the Women in Housing and Finance and Exchequer Club in Washington on Jan. 10.

The dollar also fell against the yen as one-month implied volatility for yen options against the dollar rose to 13.45 percent from 12.13 percent on Jan. 11. Higher volatility may deter so-called carry trades funded in yen as it exposes the bets to greater exchange-rate fluctuation risks.

In carry trades, investors borrow in countries with lower interest rates and invest in those with higher rates, earning the spread between the two. The risk is that currency moves erase those profits. Japan's 0.5 percent interest rate is the lowest among industrialized nations.

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