Dollar Extends Annual Loss Versus Euro, Yen on Fed Rate Cuts

Dec. 31 (Bloomberg) -- The dollar fell, completing its second annual decline against the euro and ending two years of gains versus the yen, as traders increased bets the Federal Reserve will cut rates again to counter an economic slowdown.
The dollar, trading at a two-week low versus the euro and yen, has weakened against 14 of the 16 most active currencies this year as the Fed cut borrowing costs three times as the housing market slumped. A report today may show sales of existing homes in the U.S. held at the lowest since the National Association of Realtors began keeping records in 1999.
``The U.S. economy is still slowing,'' said Lee Wai Tuck, a currency strategist at Forecast Singapore Ltd. ``The Fed is likely to cut rates in January. It puts the dollar under downward pressure.''
The dollar fell to $1.4747 per euro as of 11:41 a.m. in Singapore from $1.4723 in New York on Dec. 28. It has lost 10.4 percent this year, and reached $1.4967 on Nov. 23, the weakest since the euro began trading in 1999. The dollar fell to 111.79 yen from 112.28 on Dec. 28 and 119.05 at the end of 2006. It may decline to $1.4780 per euro today, Lee said.
Foreign-exchange trading will be less than half of normal levels today because of holidays in Japan, Indonesia, Thailand and the Philippines, Lee said.
Movements in currency markets may also be exaggerated, said Peter Pontikis, treasury strategist at Suncorp-Metway Ltd. in Brisbane, Australia.
``Illiquid conditions are dominating today,'' Pontikis said ``That's exacerbating moves at the moment.''
Volatility Rises
Implied volatility on one-week options for the dollar against the yen rose to 11.05 percent from 10.25 percent Dec. 28. Traders use implied volatility to gauge expectations for currency swings and as part of setting option prices.
The British pound headed for a second annual gain versus the U.S. currency, rising 1.9 percent to $1.9978. The Canadian dollar was poised for its biggest yearly advance since 2003, climbing 19.1 percent to 97.88 Canadian cents per U.S. dollar.
The yen has fallen against nine of the 16 major currencies this year as investors bought higher-yielding assets funded by loans in Japan, known as carry trades. It declined the most against Brazil's real, dropping 11.2 percent to 62.7759 yen. It also traded at 164.82 per euro, having weakened 4.7 percent to head for an eighth straight annual loss.
Lowest Rate
The Bank of Japan's benchmark interest rate of 0.5 percent, the lowest in the industrialized world, compares with 11.25 percent in Brazil and 4 percent in the 13-nation region sharing the euro.
In carry trades, investors borrow funds in countries with lower lending rates and use the cash to buy debt in nations that offer higher returns. Currency fluctuations can erase the profits earned.
Odds the Fed will cut its target rate for overnight bank loans a quarter-percentage point from 4.25 percent at its Jan. 30 meeting increased to 90 percent from 80 percent a week earlier, according to futures on the Chicago Board of Trade.
Sales of existing homes probably stayed at an annual rate of 4.97 million in November, the same as the prior month, according to the National Association of Realtors, which will release the report at 10 a.m. in Washington. Sales of new homes in the U.S. fell to a 12-year low last month, a government report showed Dec. 28.
The share of global foreign-exchange reserves held in dollars fell to a record low in the third quarter as demand for U.S. assets waned after the subprime-mortgage market collapsed, according to a Dec. 28 report from the International Monetary Fund. The data suggest central banks diversified out of the dollar as it weakened to the lowest in a decade.
The Fed's trade-weighted broad dollar index, a measure of the U.S. currency's value against its counterparts from the biggest American trading partners, reached a record low of 97.38 on Nov. 7.
Automatic Orders
The yen's advance against the dollar accelerated after it rose beyond 112.20 and 112.00, where automatic orders to buy the currency were placed, said Takashi Yamamoto, chief dealer at Mitsubishi UFJ Trust & Banking Corp. in Singapore.
Traders sometimes place automatic instructions to limit losses in case their bets go the wrong way.
The Japanese currency also may gain on prospects the Bank of Japan will keep interest rates unchanged while the Fed lowers borrowing costs, diminishing the allure of dollar-denominated assets. The yield premium investors earn on two-year Treasuries over similar-maturity Japanese government bonds was 2.39 percentage points, the lowest since Dec. 20.
``A rate hike in Japan is unlikely and U.S. rates may fall, so this could lead to a weaker dollar versus the yen,'' Yamamoto said. ``The yen may be bought'' to 111.00 against the dollar today, Yamamoto forecast.
The odds the Bank of Japan will lift rates at its next meeting on Jan. 22 were unchanged at zero percent on Dec. 28, based on calculations by Credit Suisse Group using overnight interest-rate swaps. -www.bloomberg.com