Dollar Trades Near Record Low Versus Euro on Fed Rate Cut Bets

Sept. 11 -- The dollar traded near a record low against the euro after Federal Reserve officials signaled the need for lower interest rates, eroding demand for dollar- denominated assets.

The U.S. currency has had the longest slide in seven weeks after Fed Governor Frederic Mishkin and Fed Bank of San Francisco President Janet Yellen said yesterday credit-market losses may slow growth. The dollar has fallen almost 1 percent since Sept. 6, the day before a government report showed the economy unexpectedly lost jobs in August.

``The market is still shell-shocked,'' said Paul Bednarczyk, currency strategist at 4Cast Ltd. in London. ``The dollar will weaken a bit more.''

The dollar was little changed at $1.3790 per euro by 9:19 a.m. in London, after falling as much as 0.4 percent yesterday. It reached a record low of $1.3852 on July 24.

The U.S. currency fell to 113.58 yen, from 113.71 yen yesterday.

The dollar declined for a fourth day yesterday as Mishkin said there's an ``important downside risk'' to the world's biggest economy and Yellen highlighted ``significant downward pressure.''

U.S. two-year Treasuries yielded 3 basis points less than similar-maturity German bunds amid speculation the Fed will cut its main rate at the Sept. 18 meeting. The U.S. notes lost their yield advantage for the first time in three years on Sept. 5.

`Ongoing Weakness'

``We have ongoing dollar weakness ahead of the Fed meeting,'' said Tony Morriss, currency strategist at Australia & New Zealand Banking Group Ltd. in Sydney. ``With the Fed about to cut rates, possibly aggressively, and the European Central Bank at least holding the line, it looks like the rate differential has moved in the euro's favor.''

A government report today may show the U.S. trade deficit widened to $59 billion in July, from $58.1 billion the month before, according to the median estimate of 70 economists surveyed by Bloomberg News. A bigger shortfall signals the dollar may need to weaken to bolster exports and limit imports.

Interest-rate futures show a 76 percent chance the Fed will lower borrowing costs by half a percentage point to 4.75 percent next week. A month ago, traders were only looking for a quarter- point cut.

Losses in the dollar may be limited, according to UBS AG. The currency is ``oversold'' and will rally 4.3 percent against the euro in the next three months, as risk-aversion prompts U.S. investors to return money home, the Swiss bank predicts. The U.S. currency will end the year at $1.36 per euro, according to the median estimate of 43 strategists surveyed by Bloomberg.

Central Banks

Central banks around the world are also unlikely to sell significant holdings of Treasuries while yields remain higher than those in Germany and Japan, said Mansoor Mohi-uddin, head of currency strategy at UBS. That will stoke demand for the dollar. Investors last month bought U.S. government bonds, considered amongst the world's safest assets, on concern the subprime mortgage crisis would slow the economy.

``Repatriation flows should support the dollar,'' Zurich- based Mohi-uddin wrote in a research note yesterday.``Foreign reserve managers are unlikely to start dumping their dollar assets en masse.''

The yen rose to 230.15 per British pound from 230.58 yesterday. It was little changed versus Australia's dollar, at 93.84.

The yen was buoyed as the yield spread between two-year U.S. and Japanese bonds narrowed to near the least since January 2005. That prompted some investors to reduce holdings of higher- yielding securities funded by loans from Japan, known as the carry trade.

``The yen carry trade has died,'' said Hideki Amikura, deputy general manager of foreign exchange at Nomura Trust & Banking Co. in Tokyo. ``It won't come back, at least this year. The credibility of high-yielding currencies collapsed.''

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 two rates. The risk is that currency moves erase their profits.

By Lukanyo Mnyanda and Ron Harui(Bloomberg)

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