Euro slides to 3-week low as Fed rate repricing buoys dollar

LONDON: The euro dipped below $1.12 to a three-week low against a stronger dollar on Tuesday as investors re-assessed their expectations of how much the Federal Reserve may cut interest rates by this month.

The nomination of IMF Chairwoman Christine Lagarde as the new head of the European Central Bank added to market participants' worries that the ECB would be inclined to ease monetary policy faster than its US counterpart.

"The euro's failure to sustain a break higher reflects in part building expectations for more aggressive ECB easing, which has been reinforced by the recent nomination of Christine Lagarde to replace Mario Draghi as president when his term ends in October," said MUFG analyst Lee Hardman in a note to clients.

The common currency fell to its lowest since mid-June at $1.1193.

The dollar index, which measures the greenback against a basket of other currencies, rose 0.2% to 97.554, a three-week high.

Expectations of a 50-basis-point cut by the Fed have fallen to 4.9% from 25% seen last week, according to the CME FedWatch Tool. Investors also think there is a higher chance the Fed will not cut rates at the September meeting.

Still, money markets are pricing in a 95% probability of a 25-basis-point rate cut at the central bank's July 31 meeting, according to FedWatch. A week ago, they saw a 75% chance of a cut.

Fed chief Jerome Powell's comments during two days of testimony to Congress beginning on Wednesday will be watched to determine whether traders will continue to reduce bets for deep interest rate cuts.

A cooling in the US-China trade dispute since the G20 summit in Japan has also added to dollar strength.

In the long run, however, hopes of better relations between the United States and the rest of the world could dampen appetite for the dollar, given the greenback has benefited from safe-haven flows, as could rising expectations of slower US economic growth.

"The greenback is likely to be affected by weaker economic fundamentals as the Federal Reserve strikes a more interventionist tone, trade war tensions abate and the country's trade and fiscal deficits both continue to swell," said Didier Saint-Georges, Managing Director at Carmignac.

"This line of reasoning has led us to keep our currency risk low, with the result that we are overweight the euro and have only limited US dollar and yen exposure," Carmignac said.

Elsewhere, the British pound dropped to a new six-month low of $1.2457, with Brexit jitters and growing expectations of a BoE rate cut adding to sterling's weakness. Excluding January's "flash crash", the currency is close to lows last seen in April 2017.

The Turkish lira steadied after sharp declines caused by President Tayyip Erdogan's dismissal of the central bank governor over the weekend, a move that prompted worries about the bank's independence.

The lira at one point slid to a two-week low of 5.8245 to the dollar and was last quoted at 5.7222.