Dollar Set for Biggest Weekly Advance Against Euro Since March

By Kosuke Goto and Stanley White

April 25 (Bloomberg) -- The dollar headed for its biggest weekly gain in a month against the euro and a second winning week against the yen on increasing speculation the Federal Reserve will stop cutting interest rates.

The U.S. currency held near a two-week high versus the euro as the extra yield two-year German government bonds pay over similar-maturity Treasuries narrowed to the least since Feb. 27. The yen weakened against the South African rand as falling expectations for exchange-rate swings encouraged investors to add to holdings of higher-yielding assets funded in Japan.

``We have started to see a bit less panic in the U.S. and that also translates to expectations that the Fed rate cuts might be coming close to an end,'' Naomi Fink, a strategist in Tokyo at Bank of Tokyo Mitsubishi UFJ Ltd., Japan's second- largest, said in an interview with Bloomberg Television. ``We probably should be seeing a bit less support for euro-dollar.''

The dollar traded at $1.5677 per euro at 6 a.m. in London from $1.5682 in New York yesterday and $1.5817 on April 18, heading for a gain of 0.8 percent this week. The dollar may rise above $1.50 by year-end, Fink said. The U.S. currency held at 104.15 yen from 104.26 yen yesterday and 103.67 yen a week ago. Japan's currency was at 163.26 per euro from 163.45 yesterday.

The yen was little changed after a government report showed Japan's core consumer prices 1.2 percent in March from a year earlier, the most in a decade. Japan's five-year notes headed for the biggest slump in almost nine years after today's inflation data added to speculation the Bank of Japan will increase interest rates this year.

Risk Appetite

Japan's currency fell to 13.5525 against South Africa's rand from 13.5294 as rising equity markets boosted confidence in higher-yielding assets. The Nikkei 225 Stock Average climbed 2.2 percent. In carry trades, investors get funds in a country with low borrowing costs and invest in one with higher rates, earning the spread. The risk is that currency swings erase those profits. Japan's 0.5 percent benchmark interest rate compares with 11.5 percent in South Africa.

The dollar may extend gains against the yen as a decline in measures of volatility suggests increased appetite for risk, according to Citigroup Global Markets Inc. analysts led by Tom Fitzpatrick wrote in research note dated yesterday.

Implied volatility on dollar-yen options expiring in one month with a strike price near current levels fell to 12.7 percent today from 24 percent on March 17, the highest since January 1999. Traders quote the gauge of expectations for future price swings, as part of pricing options.

Dollar Gains

``The largely straight-line rally in dollar-yen from March 17 came concurrent with the broader stabilization in risk appetite,'' according to the research note. ``This could open the door to additional short-term yen depreciation.''

The dollar may rise to 108.62 yen provided it breaks above 104.95 yen, the report said. First resistance at 104.95 yen is near the dollar's Jan. 23 low, and second resistance at 108.62 yen is the currency's Feb. 14 low. Resistance is a level where sell orders may be clustered.

The Dollar Index traded on ICE futures in New York, which tracks the U.S. currency against those of six trading partners, rose to as high as 72.610 today and approached the highest level since April 3. It dropped to a record of 70.698 on March 17. The U.S. currency fell to $1.6019 on April 22, the lowest level since the euro's 1999 debut. It traded at $1.9742 against the British pound from $1.9740 and was at 1.0357 versus the Swiss franc from 1.0355.

Flattening Curve

The dollar rose as durable-goods orders excluding transportation equipment increased more than forecast in March, signaling parts of the U.S. economy are weathering a housing slump.

Futures on the Chicago Board of Trade showed an 18 percent chance the U.S. central bank will hold the target lending rate at 2.25 percent on April 30, compared with no chance a week ago. There's an 82 percent likelihood of a cut to 2 percent. Two-year German government bonds yield 1.41 percentage points more than similar-maturity Treasuries.

The dollar is likely to be supported against the yen as the Treasury yield curve is flattening, showing growing expectations for the Fed to pause its rate cuts, according to BNP Paribas SA, France's largest bank. The yield curve is a graph that charts the yields of bonds with different maturities.

The extra yield 10-year Treasuries pay over two-year notes narrowed to 1.42 percentage points today from an almost four year-high of 2.08 percentage points on March 6.

Inflation Outlook

``The flattening yield curve comes in line with the Fed getting more concerned about the inflation outlook,'' BNP Paribas analysts led by Hans-Guenter Redeker wrote in a research note yesterday. ``We expect the dollar-yen to remain bid.''

Investors should buy dollars with a target of 105 yen and an selling order at 103.20 yen to limit losses, the report said.

The euro weakened against the dollar yesterday as the Munich-based Ifo institute said its German business climate index, based on a survey of 7,000 executives, fell to 102.4 this month, from 104.8 in March.

European Central Bank President Jean-Claude Trichet told reporters at a conference in Frankfurt yesterday that he is concerned the euro's surge may hurt the economy. The euro has appreciated 7 percent this year against the dollar on speculation inflation and higher fuel prices will discourage the ECB from lowering borrowing costs from 4 percent.

The euro versus the dollar has had a correlation of 0.96 with the price of crude oil over the past 12 months, according to data compiled by Bloomberg. A reading of 1 would mean they move in lockstep. Crude for June delivery rose to a record $119.90 on April 22 and dropped to $115.95 a barrel today.

``Dollar weakness had boosted speculative investment in oil,'' said Michiyoshi Kato, a senior vice president of currency sales in Tokyo at Mizuho Corporate Bank Ltd., Japan's third- largest bank by assets. ``Higher oil then had further prompted dollar-selling and euro-buying. This is reversing now.''

The dollar may move between $1.5630 and $1.5760 a euro today, Kato forecast.

To contact the reporters on this story: Kosuke Goto in Tokyo at kgoto2@bloomberg.net; Stanley White in Tokyo at swhite28@bloomberg.net

Last Updated: April 25, 2008 01:18