Dollar Trades Near Two-Month Low on Outlook for Fed Rate Cut

By Stanley White

Dec. 16 (Bloomberg) -- The dollar traded near a two-month low against the euro on speculation the Federal Reserve will cut the target rate for overnight lending to a record low today.

The greenback was also near the weakest level in 13 years against the yen before a U.S. Commerce Department report that economists say will show housing starts dropped last month to the least since records began in 1959. The Fed may also provide details today on whether it will buy government debt to push down Treasury yields and stimulate lending.

“Selling the dollar is the most likely scenario,” said Osao Iizuka, head of foreign-exchange trading at Sumitomo Trust & Banking Co. in Tokyo. “Whatever the Fed comes up with, it’s not likely to spark a sudden turnaround in the U.S. economy. It’s difficult to expect a recovery in the dollar.”

The dollar fell to $1.3727 per euro, the weakest level since Oct. 14, before trading at $1.3716 at 1:26 p.m. in Tokyo from $1.3688 late yesterday in New York. The dollar was at 90.51 yen from 90.65 yen. It dropped to 88.53 yen on Dec. 12, the lowest level since August 1995. The euro was at 124.15 yen from 124.09 yen. The dollar may decline to $1.3750 today, Iizuka said.

The U.S. currency gained 6.4 percent against the euro this year, 30 percent versus the British pound and 6.3 percent against the Danish krone as investors bought the greenback to flee riskier assets and repay dollar-denominated loans from lenders reining in credit.

Annual Gain

The yen strengthened 61 percent against the Australian dollar and 82 percent against South Africa’s rand in 2008 as $990 billion of credit-market losses sparked a reversal in carry trades, where investors get funds in a country with low borrowing costs and buy higher-yielding assets. Japan’s 0.3 percent target rate is the lowest among major economies.

Futures on the Chicago Board of Trade showed a 68 percent chance the Fed will trim its 1 percent target rate for overnight lending between banks today to an all-time low of 0.25 percent, compared with zero odds a month ago.

The U.S. central bank has limited room to lower interest rates and may use less conventional policies, such as buying Treasuries, Chairman Ben S. Bernanke said on Dec. 1.

The difference in yield, or spread, between 10-year Treasuries and similar-maturity Japanese government debt narrowed to 1.10 percentage points today, the least since June 1993. The dollar-yen’s correlation with the 10-year yield spread is 0.8 this month, according to Bloomberg calculations. A reading of 1 would mean the two variables move in lockstep.

‘Dollar’s Downtrend’

“The dollar’s downtrend against the yen will continue,” said Masafumi Yamamoto, head of foreign-exchange strategy for Japan at Royal Bank of Scotland Group Plc in Tokyo and a former Bank of Japan currency trader. “The Fed will have to say something about quantitative easing to show how they will move policy forward. This depresses Treasury yields and makes dollar assets unattractive.”

The dollar may decline to 88 yen by March 31, he said.

The U.S. housing slump that triggered the credit crisis and the ensuing recession shows no signs of abating. New-home starts in November dropped to a 736,000 annual pace, the lowest level since records began in 1959, the Commerce Department is forecast by economists to report today before the Fed’s decision.

The Bush administration is moving with “deliberative speed” in considering possible financing for U.S. automakers, Treasury Secretary Henry Paulson said yesterday in an interview with Fox News and Fox Business Network, according to an e-mailed transcript. General Motors Corp. and Chrysler LLC may be only weeks from insolvency, the companies said in congressional hearings on Dec. 4 and Dec. 5.

Bad News

“Bad U.S. economic news is now hurting the dollar rather than helping it,” Nizam Idris, a strategist at UBS AG in Singapore, wrote in a report today. “Investors are increasingly nervous about another Fed rate cut and increasing government debt issuance. The Bush administration is attempting to figure out how much aid they can provide.”

The U.S. Treasury reported yesterday that international demand for long-term U.S. financial assets weakened in October as foreign investors bought fewer American stocks, corporate bonds and agency debt.

Total net purchases of long-term equities, notes and bonds fell to a net $1.5 billion in October from $65.4 billion the previous month, the Treasury said in Washington. Including short-term securities such as stock swaps, foreigners bought a net $286.3 billion, compared with net buying of $142.6 billion the previous month.

To contact the reporter on this story: Stanley White in Tokyo at swhite28@bloomberg.net.