The dollar languished uncomfortably close to record lows versus the euro on Monday as investors counted on an imminent cut in US interest rates, with more to come in the months ahead. Trading was thin with Tokyo on holiday but there was enough demand to keep the euro firm at $1.3882 and well within striking distance of last week's all-time highs around $1.3927.
Traders reported solid support around $1.3845, which should hold while the world waits to see what the Federal Reserve delivers at its policy meeting on Tuesday. The market is convinced the central bank will cut the 5.25 percent funds rate by at least 25 basis points to help cushion the economy from the impact of the housing slump.
"The Fed's policy meeting is looking more and more like a watershed event, not only for the US markets but also for the entire global economy," said Robert Henderson, chief economist markets at nabCapital.
He believes the Fed will not only cut by 25 basis points on Tuesday but by matching amounts in October and December. In contrast, several policymakers from the European Central Bank warned over the weekend that inflation risks in the euro zone were still on the high side, leaving the door open for a tightening once credit markets calmed down.
Likewise, the Bank of Japan is still inclined to raise rates even if it stands pat as expected at its policy meeting this week. "With key US economic data printing softer and with inflation having eased in the past few months, the case for a lowering of the Fed funds rate would be building even in the absence of the recent strains in the financial system," said Darren Gibbs, chief economist at Deutsche Bank.
"When these strains are factored in, the case for a 50 basis point cut appears quite persuasive," he added. Still, Gibbs noted that Fed officials had sounded less than unanimous on how much of an easing was warranted, suggesting a more cautious 25 basis point move was more realistic.
Former Fed Chairman Alan Greenspan added to the mixed message on Sunday, saying the US housing slump was set to be worse than anyone currently expected, while also cautioning the present Fed chief not to ease too aggressively because of the increasing threat of future inflation.
Tentative signs of a revival in risk appetite last week helped equities rally across the globe, while hurting the yen as investors re-established carry trades - where investors borrow in a low-yield currency to invest in a high-yield one.
The tolerance of risk could change again this week when major US investment banks release their latest results, perhaps showing just how costly the credit squeeze has been.
On Monday, one US dollar was buying 115.25 yen, steady from New York's close on Friday but well above last week's 112.58 trough. Nevertheless, analysts felt the broader trend was still for a weaker US dollar that given the risks to the US economy were seen as greater than for the euro zone and Asia. Measured against a basket of major currencies, the dollar hit a 15-year low of 79.30 last week before crawling up to 79.60.
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