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Tuesday January 29, 2008 - 21:20:48 GMT
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FOREX NEWS-Dollar creeps higher as all eyes turn to Fed

Tue Jan 29, 2008 4:11pm EST

(Updates prices, adds quote)

By Steven C. Johnson

NEW YORK, Jan 29 (Reuters) - The dollar edged up against the euro and yen on Tuesday after mixed U.S. economic data prompted traders to trim bets against the greenback ahead of this week's interest rate decision by the Federal Reserve.

Financial markets expect the central bank to reduce benchmark lending rates on Wednesday, though better-than-expected data on consumer confidence and durable goods orders helped cut through some of the gloom surrounding the U.S. economic outlook.

Separate data showed more U.S. housing sector trouble, but that familiar story was absorbed easily by the market.

"Traders have become far more realistic, realizing the world has not come to an end, and stocks have stabilized," said Kathy Lien, chief strategist at in New York.

By late afternoon, short-term interest rate futures reflected about a 78 percent chance of a 50-basis-point Fed rate cut, from 86 percent on Monday. The number had slipped as low as 60 percent after Tuesday's data.

"The Fed will probably cut by 50 basis points, though I think there's a greater chance of a 25-basis-point cut than people realize with Congress' plans for fiscal stimulus giving the stock market an important extra nudge higher," said Ashraf Laidi, chief market analyst at CMC Markets in New York.

The euro slipped to $1.4772 <EUR=>, down 0.1 percent from late Monday. Before Tuesday, the dollar had fallen against the euro in four of the last five trading sessions after the Fed startled markets by slashing benchmark rates by 75 basis points to 3.5 percent in an emergency move last week.

The dollar rose 0.2 percent to 107.05 yen <JPY=>, near a session peak of 107.23 yen hit after the durables data.


If the Fed cuts rates by 50 basis points after its meeting, that would bring the federal funds rate down to 3 percent, a full percentage point below the euro zone benchmark rate and among the lowest in the industrialized world.

A lower yield would presumably make the dollar a less attractive currency in which to hold investments.

If the Fed cuts by 50 basis points, the cumulative 125 basis points of easing would be the biggest move in a two-week span since the U.S. central bank began using the federal funds rate as its primary policy tool in the early 1990s.

If such a cut is accompanied by more relatively positive U.S. economic data, investors may stampede back into the market hunting for higher-yielding, higher-risk investments, said Mark Frey, head trader with Custom House, a currency services firm in Victoria, British Columbia.

"The carry trade will be back in vogue and the U.S. dollar will likely struggle, especially against the euro and the commodity currencies," Frey said. In carry trades, investors borrow in low-yielding currencies such as the yen in order to make investments in currencies bearing higher rates.

The high-yielding Australian dollar would be one of the biggest beneficiaries, CMC Markets' Laidi said, and could rise to US$0.90 <AUD=>. It last traded up 0.1 percent at US$0.8891.

Dealers and investors would like to see what the Fed, in the statement accompanying its policy decision, has to say about the risks ahead for economic growth -- especially with fourth-quarter U.S. gross domestic product data and the January employment report due later this week. (Additional reporting by Kevin Plumberg and Lucia Mutikani; Editing by Jonathan Oatis)

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