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Dollar steadies before Fed, mkt still wary on risk

Risk aversion fuelled by the deepening malaise in credit markets remained a consistent theme as the low-yielding yen stayed well bid versus the greenback.

Broadly speaking however, the dollar had entered calmer waters after taking a lead from equity market performance as a solid Wall Street close on Monday was echoed by rising European stocks in early trade.

Monday’s 2 percent rally in US stocks helped ease investor worries about a credit squeeze, but analysts were still expecting the US central bank to acknowledge recent turbulence after a widely-expected decision to leave rates on hold later.

“Equity markets are doing all the driving at the moment and that continues to be the case. Last night the strong bounce in US equities had helped calm markets ahead of the Fed today,” said Mitul Kotecha, head of global foreign exchange research at Calyon.

Markets are expecting the Fed’s monetary policy meeting to hold rates steady at 5.25 percent, but an easing in the fourth quarter of this year has been priced in -- leading to speculation that some shift in stance is likely.

“No-one is expecting the Fed to move rates but the statement will be very, very important. It seems that they will maintain that the inflation risk is predominant, but markets are looking for any comments whatsoever on the state of the debacle in credit markets,” Kotecha said.

By 0828 GMT, the dollar was down 0.1 percent on the day at 118.71 yen, edging down from overnight highs above 119.00 yen but staying well above a four-month low of 117.19 yen hit on Monday.

The euro was flat at $1.3803, still within striking distance of last month’s record peak above $1.3850, and also held steady at 163.85 yen.

The dollar index, a measure of the greenback’s value against a basket of six of its most heavily traded counterparts, was at 80.27, off a 15-year low hit the previous session when it fell below 80.00.

Risk wary

Risk aversion was reflected in the high-yielding New Zealand dollar, which fell 0.4 percent to 90.62 yen while the greenback was down 0.1 percent at 1.1900 Swiss francs, off a two-year low hit on Monday.

UBS said its Risk Index remained in strong risk-averse territory. “Main drivers of this development were widening high yielders’ spreads and increasing FX volatility. In contrast, equity volatility decreased,” it added.

One month euro/dollar implied volumes were sitting near levels last seen in April.

Analysts are broadly expecting the Fed to reiterate its previous view in its statement, emphasising price pressures as the predominant risk to its scenario for the economy, but see scope for it to tweak its language.

“We see room for the Fed to alter its ’balance of risks’ statement in favour of downside risks over the next two meetings, especially as current conditions are not dissimilar to those back in March, the last time the Fed’s hawkish bias was downgraded,” Tullett Prebon G7 economist Lena Komileva said in a note to clients.

The dollar could gain if the Fed sticks to its previous view, but the direction of the US currency will be dictated by the stock market’s reaction to the Fed’s post-meeting statement, traders said.