The dollar hit its highest in a month against the yen on Wednesday, reflecting a jump in Treasury yields this week that has helped prod the US currency to three-month highs in trade-weighted terms. The Swedish crown was the biggest gainer among the main European currencies, driven higher by better than expected industrial output data.
Longer-dated US Treasury yields have risen 20 basis points in the past week and the spread between two-year German and US government bonds - the most directly responsive to interest rate moves - is within a whisker of its highest since mid-2007. Hanging over the market are expectations the European Central Bank will take action on Thursday to support growth that would put official returns on euros into negative territory.
That has provoked some yo-yo moves for the euro in recent days but the week's dominant trend is for a stronger dollar. "What we've seen this week is reality bites and it's as simple as that," said Simon Derrick, head of currency research at Bank of New York Mellon in London.
"There is a realisation taking place that the Fed is concerned by the scale of risk-taking that is going on and as such it will plough on with tapering (of bond-buying) and will be as realistic on monetary policy as it can be." Disappointment over the pace of US economic growth in the first quarter meant the dollar defied recommendations put out by banks and investment houses at the start of 2014 for a surge in its value.
But expectations the ECB is headed for further action to ease policy have reinforced the base case for a stronger US currency - that returns on US government debt will rise while those in the euro area fall. Two-year US yields stood at 0.403 percent, a 34 bps premium over the equivalent Bund. It has only been higher than that once - 35 bps briefly in May 2010 - since the financial turmoil of 2007 and 2008.
In European trade, the dollar gained 0.2 percent to 102.665 yen, was up less than 0.1 percent against the euro at $1.3621 and a touch lower versus the pound at $1.6736. There have been question marks over the health of the Swedish economy, hit as elsewhere in Europe by the threat of deflation, and a 3.0 percent rise in industrial production in April, compared with March, did something to settle those nerves.
Production had fallen in March and the crown gained a third of a percent against the euro . It remains within 1 percent of one-year lows against the euro and dollar. "Shorts in the euro against the crown could perform well ahead of the ECB after the positive data surprises and revisions this morning," Citibank strategist Josh O'Byrne said.
"The Swedish crown seems likely to outperform the Norwegian crown with markets rewarding better market liquidity." With expectations apparently strong that the ECB will cut its deposit rate on Thursday, the key question for short-term players is whether that action - and any additional measures that may well accompany it - is fully priced in to the euro. A number of dealers in money and foreign exchange markets said they thought that was not yet the case.
"If you forced me to take a view on spot (euros), then I would say it will go down," BNY Mellon's Derrick said. "As to how I would trade it, I think I would get myself long of volatility. By any historical reference point, vols are still amazingly low." That refers to another of this year's big trends - the collapse in the volatility of major exchange rates which banks traditionally need to generate trade and hence returns. Their hope is that ECB action may trigger larger moves. One-month vols have jumped from 4.8 percent - the lowest since 2007 - to 6.6 percent on Wednesday.
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