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Friday August 11, 2006 - 22:22:20 GMT
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FOREX-Dollar climbs in week even with Fed on hold

FOREX-Dollar climbs in week even with Fed on hold
Fri Aug 11, 2006 4:34pm ET163

(Updates prices, adds positioning data)

By Kevin Plumberg

NEW YORK, Aug 11 (Reuters) - The dollar rose on Friday, capping its largest one-week rise in nearly a month on the view the Federal Reserve may not be able to keep official U.S. interest rates steady for long.

A surprisingly strong U.S. retail sales report for July stoked speculation that rate hikes could resume even although the Fed only on Tuesday paused its tightening campaign of some two years with benchmark short-term rates at 5.25 percent.

That supported the dollar, particularly against lower-yielding currencies, although dealers were reluctant to take large positions ahead of the weekend and with U.S. inflation data due next week.

"The robust retail sales report was the final blow in what has proved to be an ill-fated week of dollar positives for dollar bears," said Michael Woolfolk, senior currency strategist with Bank of New York.

"Expectations that the Fed will begin cutting rates next year appear to be premature, while the risk of further rate hikes later this year will be squarely focused on upcoming core inflation data," he said in a note.

By late afternoon in New York, the euro was down 0.5 percent at $1.2725, within sight of intraday lows of $1.2715 reached after the retail sales data.

Against the yen, the dollar rose 0.9 percent to 116.30 yen after Japan's second-quarter economic growth figures trailed expectations, leading investors to believe the Bank of Japan will be able to tighten monetary policy only gradually.

In a volatile session, sterling slipped 0.2 percent to $1.8902, although it has fought back from losses suffered on Thursday when British police uncovered a plot to blow up commercial airliners over the Atlantic.


The dollar has performed relatively well this week despite a pause in the Fed's rate-raising campaign which had boosted the greenback for over a year. It rose 1 percent against a group of major currencies <.DXY> this week, its biggest gain since the week ended July 16.

Speculative investors amassed a net short dollar position worth $17.6 billion in the week ended Tuesday compared with $13.2 billion in the prior week, the latest data from the Commodity Futures Trading Commission showed. They also extended their net long sterling and euro positions to records.

So dollar strength in ensuing days could have been primarily the unwinding of these positions.

While Friday's U.S. retail sales report fueled expectations the Fed could at some point resume raising rates in the current cycle, investors became more open to risk with the U.S. central bank on hold for now.

Traders said higher-yielding currencies have been in demand this week for the carry trade, where investors borrow in a low-yielding currency to buy high-yielding ones, while traditional funding currencies like the yen and the Swiss franc have been consistently sold.

"The talk in the market is that people are looking for yield in the Canadian dollar, Australian dollar, New Zealand dollar and South African rand, using Swiss and yen to finance it," said a trader with a U.S. proprietary trading firm.

The New Zealand dollar , the highest-yielding currency of the G10, was up 0.1 percent at $0.6335, while the Australian dollar slipped 0.2 percent to $0.7655.

Persistent use of carry trades has caused the Swiss franc and yen to be significantly undervalued by some measures and others like sterling and the Australian dollar to be overvalued, BNP Paribas analysts said in a research note.

Nonetheless a correction may not yet be in the offing.

"Current currency valuation extremes would not have been reached if markets had not been so preoccupied with carry trades for so long," they said. "Current valuations have been extreme, but so have carry trade conditions."

© Reuters 2006. All Rights Reserved.


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