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Wednesday October 27, 2010 - 21:09:00 GMT
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FOREX NEWS - Dollar rallies as Fed policy questions swirl

2:45pm EDT

* Dollar higher year to date with Wednesday's gain

* Dollar rises to 2-week high vs yen, 1-wk high vs euro

* Uncertainty reins on size and scope of Fed easing

(Updates prices, adds details, adds quote, byline)

By Steven C. Johnson and Nick Olivari

NEW YORK, Oct 27 (Reuters) - The dollar's rise on Wednesday pushed it into positive territory against major currencies for the year as investors continued to unwind bets against the greenback before a highly anticipated Federal Reserve meeting.

The U.S. central bank has telegraphed several times that it will attempt to boost growth by pumping more money into the economy through government bond purchases, and that has pushed the dollar and U.S. bond yields lower in recent months.

But the anti-dollar trend started to stall this week as questions about how much the Fed will spend and whether the new measures will be carried out swiftly or phased in over time.

The dollar rebound tracked a rise in U.S. bond yields and a narrowing of the gap between them and rates in Germany and Japan. By Wednesday, an index of the dollar against six major currencies .DXY, was back in positive territory for 2010.

Primary dealers polled by Reuters last week were anticipating the Fed would buy at least $500 billion of Treasuries [FED/R]. Those expectations have been since been scaled back.See [ID:nN25168493] and [ID:nTOE69Q02H].

"Whether they (the Fed) actually give a size for the amount of stimulus is questionable," said Anthony King, managing director of investment grade fixed income at PineBridge Investments in London. PineBridge Investments manage more than US $78 billion in assets.

"That's why the dollar has strengthened somewhat this week because market commentators had been leaning too far in the other direction," King said.

The Fed will hold its next policy meeting on Nov. 2-3.

The dollar hit a two-week high just shy of 82 yen JPY= and a one-week peak at $1.3741 per euro EUR=, which was also undermined by euro zone banks taking up more cheap funding than expected at a three-month ECB tender [ID:nLDE69Q0XN].

Traders said the break below $1.3750 could prompt a test of last week's low around $1.3695.


Many analysts say the gap between euro zone and U.S. short-term rates means the euro is unlikely to fall below $1.35 in coming months. Investors expect the European Central Bank to withdraw some stimulus measures as the Fed eases, which should keep euro zone interest rates higher than U.S. rates.

King said the euro could rebound after the Fed ends the suspense next week, but predicted gains would be limited.

"It's possible we could see $1.45 versus the euro. But I wouldn't expect us to overshoot much more than that," he said.

Some analysts say looser U.S. policy will help the U.S. economy grow faster than the euro zone's, which could struggle in 2011 as governments try to put public finances in order with strict spending cuts and higher taxes. [ID:nN27213289] ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^ PDF on G20's uneasy truce: FX column on the Fed: [ID:nLDE69L1EY] ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^>


But uncertainty about that policy isn't helping global policymakers, particularly those in fast-growing emerging markets.

China, Brazil and others have complained that Fed policy was stoking inflation by pushing money away from the dollar and into their fast-growing economies.

These issues were prominent among discussions at a G20 meeting last week, at which finance leaders pledged not to devalue their currencies for economic advantage.

But some emerging markets have felt compelled to try to slow inflows with taxes on investment and other capital controls, and analysts said more moves in that direction could limit dollar losses.

The Korean won KRW= fell more than 1 percent Wednesday after comments from the country's central banker provoked speculation that the government may turn to capital controls [ID:nSEL003184].

"Everyone is ready to go it alone, and the problem is that nobody really has any clue what the Fed is going to do," said Brown Brothers Harriman strategist Mark McCormick.

The Australian dollar, in demand because of its high interest rates and trade links with emerging Asia, fell 1.7 percent to $0.9688 AUD=D4. Softer-than-expected inflation data contributed to the currency's decline, traders said.

(Additional reporting by Wanfeng Zhou; editing by Diane Craft)

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