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Tuesday November 2, 2010 - 20:15:41 GMT
Reuters - www.reuters.com

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FOREX NEWS - Dollar falls before Fed decision; rebound likely

3:30pm EDT

* Aussie hits parity vs US dollar for 2nd time since 1983

* U.S. dollar suffers a day before Fed policy decision

* Investors await results of U.S. midterm elections (Adds fund manager's comment, updates prices)

By Wanfeng Zhou

NEW YORK, Nov 2 (Reuters) - The U.S. dollar fell on Tuesday after Australia's surprising interest-rate hike and somepositive economic news in the euro zone, but analysts warned of a possible rebound if the Federal Reserve disappoints markets at the end of its policy meeting on Wednesday.

Investors also awaited the results of U.S. midterm elections on Tuesday. Some analysts said a Republican victory could be positive for the U.S. currency on hopes for more fiscal austerity and reduced government regulation.

But most investors have looked beyond the elections and focused instead on a two-day meeting of the Federal Open Market Committee, which looks set to announce a second round of monetary easing on Wednesday. For details, see [ID:nN01141530]

The market's expectations have centered around an initial commitment from the Fed to buy at least $500 billion in Treasury debt over five months, which was less than the $1 trillion size some traders had estimated weeks ago. Much uncertainty surrounds the scope and pace of bond purchases, however.

"I think there's every chance of a rebound in the dollar, as I think its weakness has been directly correlated to fear the Fed was going to do something of shock-and-awe nature," said Alan Wilde, head of fixed income and currency at Baring Asset Management in London.

Baring Asset Management oversees $50 billion in assets.

Analysts said the risk of a dollar recovery is building after the greenback has lost 8 percent against a basket of major currencies since the start of September on expectations the Fed will purchase more assets, a move that would pressure U.S. yields and diminish the return on dollar-denominated investments.

The U.S. Dollar Index .DXY, which tracks the greenback against a basket of currencies, was down 0.7 percent at 76.752.

The euro EUR= traded as high as $1.4058 on trading platform EBS, buoyed by a pick-up in euro-zone manufacturers' output. [ID:nLDE6A10TX] It was last up 1.1 percent at $1.4037.

Traders, however, were skeptical that the euro will be able to sustain gains above this level, given renewed worries about the region's sovereign debt issues.

Analysts also noted the S&P 500 stock index's .SPX inability to break through the 1,195-1,197 area as a sign that the euro is losing momentum ahead of the $1.41-1.42 congestive resistance. The euro and the S&P 500 have closely tracked each other, with a 15-day correlation coefficient of 0.711 on Tuesday. With less than an hour to go in Tuesday's regular U.S. stock trading session, the S&P 500 was trading at around 1,194.34, below its intraday high of 1,195.88.

DISSENTS A FACTOR

Aroop Chatterjee, currency strategist at Barclays Capital in New York, said the dollar's reaction will depend on not just the size of asset purchases, but also the commitment of policy-makers to make the asset purchases.

"If the level of commitment is more conditional than what the market expected, that would disappoint," he said. "U.S. data has been quite strong of late. Our economists think the Fed will take a more incremental approach and will make quantitative easing conditional on economic data."

Citigroup's head of G10 FX strategy Steven Englander wrote in a note that another uncertainty surrounding the Fed's program is "what the trade-off between dissents and QE2 commitments is."

No dissent, he said, even with a lower-than-expected initial commitment to an expected second round of quantitative easing, will likely eventually be seen as U.S. dollar negative as it suggests "an agreement in principle with respect to the need for QE2 and debate over the size."

In contrast, Englander said two dissents at a moderate headline quantitative easing level will be a positive for the dollar as it would suggest that "there is much more internal opposition to QE2 than the market anticipated."

<^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^

Multimedia report on run-up to the Fed meeting:

link.reuters.com/pyb23q

Top News-U.S. elections: link.reuters.com/fyq86p

^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^>

The Australian dollar hit a peak of US$1.0025 AUD=D4, the highest since the currency was floated in 1983. The Reserve Bank of Australia raised its cash rate by 25 basis points to 4.75 percent as a pre-emptive strike against inflation.

The dollar edged up 0.3 percent to 80.75 yen JPY=, though it was still close to the record low of 79.75 yen set in 1995. The risk of Japanese intervention to weaken the yen was expected to increase if the dollar slips below 80 yen. (Additional reporting by Gertrude Chavez-Dreyfuss; Editing by Jan Paschal)

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