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Dollar falls against yen, euro as hopes for a rate cut fade

The dollar had its biggest decline in two weeks against the yen as expectations waned that the Federal Reserve will cut interest rates to bolster a faltering economic recovery.

The US currency also slipped against the euro, paring its weekly gain to 1.7 percent, after a Washington Post article said speculation of a rate reduction as soon as next week "may be the product of wishful thinking."

The dollar had rallied the past three weeks in part as expectations grew that the Fed would cut rates and help lure investment to the US.

Investors are "now starting to take a more realistic view of what the Fed is going to do, which has been pushing the dollar down," said Patrick Collins, a currency trader at Ruesch International in Washington. He said he doesn't expect the Fed to cut rates next week.

The dollar declined to Japanese yen 120.16 at 5:20pm Friday in New York from Japanese yen 120.99 Thursday, trimming its weekly gain to 1.1 percent. That's the dollar's biggest one-day decline since July 24. It weakened 0.3 percent to US$0.9698 per euro, three days after reaching a seven-week high of US$0.9624.

Yields on some interest-rate future contracts rose the past two days as traders pared bets for a rate reduction.

The 1.705 percent yield on the August federal funds futures contract, a gauge of expectations for the average overnight lending rate for the month, suggests traders see about a 30 percent chance of the Fed cutting its 1.75 percent target rate at next week's meeting. That's down from a 35 percent probability seen two days ago.

"There's talk about no Fed ease, and there's some dollar selling on that," said John Cholakis, a trader at Natexis Banques Populaires.

While lower rates can weaken a currency by reducing returns on a country's fixed-income securities, analysts say a reduction now would strengthen the dollar by bolstering growth expectations and luring investors to assets such as stocks. The Standard & Poor's 500 Index completed yesterday its biggest three-day rally in almost 15 years as rate cut speculation grew.

"If the Fed cuts rates, the scare of a [contraction] in the economy will be looked upon as overdone, helping the currency,'' said Nicholas Reitenbach, the chief investment officer of Pinnacle International Management, which manages more than US$600 million.

Economic growth slowed to 1.1 percent in the second quarter from 5 percent in the first.

Morgan Stanley economist Dick Berner told his clients Friday to expect a cut next week even after a three-day surge in stocks eased concern that the economy may fall back into recession. He said the Fed will cut the overnight rate as much as 50 basis points to 1.25 percent. That makes Morgan Stanley the only one of 22 Wall Street firms that trade with the central bank, known as primary dealers, to forecast a cut next week.

"We believe that [Fed] officials want to insure that economic hesitation does not turn into broader-based economic weakness,'' Berner said in a research note.

While Morgan Stanley is alone predicting a reduction, eight of the primary dealers say the Fed will signal at the meeting that it may cut rates in months ahead after 11 reductions in 2001. The firms predict the Fed will say weak growth is a bigger threat to the economy than inflation.

The 1.57 percent yield on the October fed funds futures contract suggests that traders see a 70 percent chance of a rate reduction at the Fed's September meeting, down from the 90 percent chance seen two days ago.

Demand for dollars also fell today after WorldCom Inc. said it found an additional US$3.3 billion in misreported financial results, renewing concern about the reliability of US corporate accounting. "WorldCom's revelation of further losses is weighing on the dollar," Cholakis said.

Evidence of a larger trade surplus in Germany, the biggest economy using Europe's common currency, also helped to boost the euro against the dollar, traders said.
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