Dollar Trades Near Record Low Against Euro Before Fed Meeting

By Ron Harui and David McIntyre

Sept. 17 (Bloomberg) -- The dollar traded within a cent of its record low against the euro and reached the weakest in 30 years versus Canada's currency on bets the Federal Reserve will lower its benchmark interest rate tomorrow.

The dollar has declined against 12 of the 16 most-active currencies this month as traders predict the Fed will cut the rate by at least a quarter percentage point. The New York Fed will say today that manufacturing in the state fell to a four- month low in September, according to a Bloomberg News survey.

``It's a U.S. dollar bearish environment,'' Sue Trinh, a currency strategist at RBC Capital Markets, said in Sydney. ``Ultimately, the Fed is the only central bank that is cutting rates at the moment.''

The dollar traded at $1.3882 per euro at 7:54 a.m. in London from $1.3875 late in New York Sept. 14. It touched $1.3927 on Sept. 13, the lowest since the single European currency was introduced in 1999. The U.S. currency dropped to C$1.0256, the weakest since February 1977, from C$1.0299 on Sept. 14. It was at 115.21 yen from 115.36.

Trinh said trading was likely to be subdued because of a public holiday in Japan. The dollar may move between $1.3850 and $1.3880 per euro and between 115.10 and 115.35 yen, she forecast.

The U.S. currency is down 0.4 percent versus the yen this month before figures that may show the New York Fed's general economic index dropped to 18.0 from 25.1 in August.

Interest-rate futures show traders see a 58 percent chance of a half-percentage-point cut in the Fed's target for the overnight lending rate between banks from 5.25 percent. That compares with no chance one month ago.

`A Bubble'

The dollar may extend losses after Venezuelan President Hugo Chavez instructed Petroleos de Venezuela SA, the state oil company, to convert its investments from dollars to euros and Asian currencies to reduce risk. Chavez, speaking in his weekly address, said yesterday the U.S. has bought goods from around the world with paper that is ``a bubble.''

The yen is poised to snap two days of losses against the dollar after the Washington-based Commodity Futures Trading Commission issued a report last week, which showed traders reversed bets on the yen declining against the U.S. dollar.

Volatility implied by one-week dollar-yen options was at 14.25 percent, unchanged from Sept. 14. Dealers quote implied volatility, a gauge of expectations for currency moves, as part of pricing options.

`Huge Flip'

The difference in the number of wagers by hedge funds and other large speculators on a gain in the yen compared with those on a drop -- so-called net longs -- was 5,585 on Sept. 11, compared with net shorts of 7,053 a week earlier. The yen has fallen 8.8 percent versus Australia's dollar in the past year as investors bought higher-yielding assets funded by loans in Japan.

``There has been a huge flip from being net short to net long,'' said Thio Chin Loo, senior currency strategist at BNP Paribas SA in Singapore. ``It goes to show the extent of unwinding of carry plays that we've had. We don't dismiss the dollar-yen having more downside'' to 105 by year-end, Thio said.

Australia's dollar, a favorite of carry trades because its interest rate is 6 percentage points higher than Japan's, traded at 97.45 yen from 97.13 yen late in New York on Sept. 14.

In carry trades, investors get funds in a country with low borrowing costs and invest in one with higher interest rates, earning the spread between the borrowing and lending rate. The risk is that currency moves erase those profits.

Rate Differentials

The euro may rise on speculation European Central Bank council member Erkki Liikanen will reiterate today the central bank's pledge to fight inflation, fueling prospects the ECB will raise interest rates while the Fed lowers. The yield premium investors earn on 10-year U.S. Treasuries over similar-maturity German bunds was 0.30 percentage point, near the 2 1/2-year low of 0.25 percentage point reached last week.

``With the ECB on hold, looking like they'd like to raise rates down the road, interest-rate differentials are clearly moving against the U.S. dollar,'' said Tony Morriss, a currency strategist at Australia & New Zealand Banking Group Ltd. in Sydney. ``That means the euro is still under some upward pressure. It could move to a record high of about $1.40 this week.''

ECB council member Mario Draghi said on Sept. 15 that the central bank is ``plainly focused on inflation expectations.'' Liikanen will speak at 2 p.m. in Turku, Finland.

Investors are betting on an ECB rate increase from 4 percent this year, interest-rate futures show. The implied yield on the December Euribor contract rose 1 basis point to 4.46 percent today. The contract settles to the three-month interbank offered rate for the euro, which has averaged about 18 basis points above the ECB's key rate since 1999.

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