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Thu 22 Sep 2011 08:52 AM

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Dollar surges after US Fed dampens risk appetite

US greenback climbs to a seven-month high against world's major currencies

Dollar surges after US Fed dampens risk appetite
Asian currencies also continued to suffer large outflows

The dollar climbed to a seven-month high against major currencies after the Federal Reserve said there were "significant downside risks" to the economy, but it stopped short of bold monetary easing, instead shifting its portfolio in favour of long-term debt.

Although few analysts expected the Fed to embark on another round of quantitative easing, the central bank's reluctance to expand its balance sheet sent shares, commodities and risk-related currencies such as the euro and the Australian dollar sharply lower.

As investors view the Fed's move as a drop in the ocean and say it is not enough to support the economic recovery, they shifted aggressively into the liquid US dollar.

As a result currencies of emerging economies like the Brazilian real and the South African rand made their biggest daily losses since the global financial crisis in 2008.

Asian currencies also continued to suffer large outflows, with the Korean won hitting a one-year low at $1177.60, down 2.5 percent on the day, and the likes of the Malaysian ringgit and Indonesian rupiah also sharply lower.

The Fed unveiled a programme, dubbed "Operation Twist," putting more downward pressure on long-term interest rates in a bid to help the ailing housing sector, but few think it is enough to seriously bolster growth in the global economy.

"Players are disappointed with the Fed's decision and are trying to do everything to hedge their risk exposure," said Koji Fukaya, chief currency strategist at Credit Suisse in Tokyo.

Additional factors seen supporting the dollar were slightly higher short-term rates and the Fed's decision not to increase the money supply.

The dollar index, the gauge of its performance against a basket of currencies, jumped to 77.956, its highest since late February.

"Short-term interest rates nudging higher may be supportive of dollar/yen, but overall the dollar's strength comes as it makes big gains against risk-linked currencies," said Fukaya.

The euro nursed overnight losses. It edged back toward a seven-month low of $1.3495 hit last week, coming off an overnight peak at $1.3800 to trade at $1.3581 with bears targeting stop-loss orders lurking around $1.3500.

As the greenback gained on all currencies, including the yen, the Japanese currency came off a 10-year peak against the euro hit earlier in the session at 103.67, to last trade up 0.5 percent at 104.25.

Euro/yen, together with Aussie/yen, were also supported by Japanese retail investors, traders said. The Australian dollar climbed 0.5 percent to 77.20 yen.

Against the dollar, the Aussie recouped some of its losses sustained in the wake of the Fed's move, but was still hovering close to parity with the US currency and last changed hands at 1.0065 -- its lowest since August 9.

"To be honest, I'm surprised to see so much risk aversion after the Fed. I didn't think that many people had expected the Fed to expand its balance sheet, but it seems like some had been hoping for a bolder easing move," said Teppei Ino, a currency analyst at Bank of Tokyo-Mitsubishi UFJ in Tokyo.

The dollar hit its session high of 76.97 yen on stop-loss buying by model funds, stopping its rally just above Wednesday's peak of 76.86 yen and resistance on daily Ichimoku charts in the 76.85 to 76.90 area.

Despite the greenback's strength traders were still wary that selling by Tokyo exporters could soon see the dollar re-test the all-time low of 75.94 yen plumbed in August.

"With this event [Operation Twist] over, the market focus now squarely shifts back to the euro zone and the next economic indicators. We all have to wait to see if Greece gets another tranche of bailout money," Ino said.

The Fed sounded downbeat on the state of the economy and said economic growth remained slow, with recent indicators pointing to continuing weakness in overall labor market conditions and the unemployment rate remaining high.

On Wednesday, Greece outlined key measures to help alleviate the country's fiscal problems.

It adopted further austerity measures to secure a bailout installment crucial to avoid running out of money next month, as the International Monetary Fund warned that Europe's sovereign debt crisis risks tearing a giant hole in banks' capital.

Against the Swiss franc, the dollar held steady around 0.9002 francs after jumping 1.5 percent overnight, pushed up by the euro which gained versus the Swissie on talk that the Swiss National Bank may lift its euro/Swiss target to 1.25 from 1.20. The SNB declined comment.

The euro last traded steady at 1.2224 francs.

The New Zealand dollar shed 0.8 percent to $0.7974, off an $0.8241 peak hit the day before, hurt by data showing New Zealand's economy grew more slowly than expected in the June quarter, backing views that the central bank is likely to keep interest rates low for longer.

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