The dollar weakened across the board on Friday, most notably against the yen, as speculation grew that the Federal Reserve may pause its rate-raising campaign next month. After touching three-month highs two days ago, the dollar exited North American trade lower against all its main rivals.
That was largely thanks to Fed Chairman Ben Bernanke, who rattled dollar bulls on Wednesday when he said he expected inflation to ease as the economy slows. "The big retreat in expectations for another Fed rate hike on August 8 is what lies behind the dramatic turnaround in the dollar we've seen this week," said Andrew Busch, global markets strategist at BMO Capital Markets in Chicago.
Fed funds futures on Friday showed that the market is now pricing in just a 43 percent chance the central bank will raise rates in August to 5.50 percent, prolonging a run of 17 straight rate hikes.
As recently as Wednesday morning, data showing a gain in US consumer prices had futures markets pricing in a 90 percent chance of an August hike. The yen rallied across the board, and extended its gains in New York trading hours after China announced it was raising its bank reserve requirements by 0.5 percentage points in a bid to cool its racing economy. Investors often buy yen as a proxy to bet on yuan strength since the Japanese currency is Asia's most heavily traded.
Late afternoon, the dollar was down 0.73 percent against the yen at 116.17 yen after dipping as low as 115.83 yen earlier, a one week trough. That brought the dollar around two yen short of a 3-month peak of 117.88 yen hit earlier in the week.
The euro hit a fresh one-week high $1.2797 and exited trade around $1.2690, up 0.5 percent on the day. Bernanke's blow earlier in the week means "there is enough ammunition for the market to make a run at $1.27, though I think it will probably have to wait until early next week," said Ron Simpson, currency strategist at Action Economics in Dobbs Ferry, New York.
Receding expectations for Fed tightening have come at a time when investors are growing more confident that the European Central Bank will raise interest rates next month, thus narrowing the yield differential between dollar and euro.
The Japanese currency added to earlier gains on the Chinese reserve requirement news. Some investors were even expecting China to unshackle the yuan further on Friday, the one-year anniversary of a 2.1 percent revaluation.
Analysts said higher reserve requirements do not necessarily mean a stronger yuan. But the move underscores authorities' concerns about an overheating Chinese economy, which along with record trade surpluses and surging foreign reserves is increasing upward pressure on the yuan.
Next week the market's attention will likely be squarely on US data, for any signs of whether the numbers tally with the Fed's view that the economy is slowing. The slate includes consumer confidence, home sales, and durable goods orders.
"If these reports come in at expectations or better, I think we could see the dollar rally," Simpson said. "The Fed is in the same boat as the markets right now. They also don't know what they're going to do. It all depends on the data."
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