Dollar Falls on Deepening U.S. Recession, Rate-Cut Speculation

By Stanley White and Ron Harui

Nov. 27 (Bloomberg) -- The dollar fell against the yen and the euro after the biggest drop in U.S. consumer spending in seven years fanned speculation the Federal Reserve will cut interest rates to help avert a prolonged recession.

The currency also declined on concern the Fed’s $800 billion plan to unfreeze credit markets will weaken the central bank’s balance sheet. Ten-year credit-default swaps used to hedge against losses on U.S. government bonds rose to a record yesterday. Indian rupee non-deliverable forwards fell on speculation overseas investors will shun the nation’s assets after terrorist attacks in Mumbai.

“The prices of the assets which the Fed buys may decline, fueling concerns over its balance sheet and damaging its credibility,” said Ryohei Muramatsu, manager of Group Treasury Asia at Commerzbank AG in Tokyo. “It’s dollar-negative.”

The dollar fell to 95.13 yen as of 6:08 a.m. in London, from 95.67 late yesterday in New York, when it rose 0.5 percent. Against the euro, it fell to $1.2922 from $1.2880, following a 1.4 percent advance yesterday. The euro bought 122.92 yen from 123.24 yen.

Rupee one-month NDFs fell 0.3 percent to 49.90 per dollar after terrorist attacks targeting foreigners in Mumbai left as many as 101 people dead and 287 injured. Forwards are agreements in which assets are bought and sold at current prices for delivery at a later specified time and date. Non-deliverable contracts are settled in dollars. Regulators closed currency, bond, stock and commodity exchanges.

U.S. Holiday

Currency moves may be exaggerated today as U.S. financial markets are closed for the Thanksgiving Day holiday, according to Mitsuru Sahara, senior currency sales manager in Tokyo at Bank of Tokyo-Mitsubishi UFJ Ltd., a unit of Japan’s biggest lender by assets.

“Terrorism in India is somewhat unsettling for currencies,” Sahara said. “We cannot rule out big swings in the market today because volume will be very light as the U.S. markets are out of the action.”

The dollar may move between 94.50 yen and 96 yen today, he said.

The ICE’s Dollar Index, which tracks the greenback against the currencies of six major trading partners, declined 0.2 percent to 85.465 after a U.S. Commerce Department report yesterday showed consumer spending dropped 1 percent in October.

Fed Futures

Futures on the Chicago Board of Trade show a 36 percent chance the Fed will cut its 1 percent target rate for overnight bank loans by 0.75 percentage point at its Dec. 16 meeting, up from 18 percent odds a week ago.

The Fed committed up to $800 billion on Nov. 25 in new funding to thaw credit flow for homebuyers, consumers and small businesses and will take on credit risk by buying debt.

The cost of a 10-year credit-default swap on U.S. government bonds jumped six basis points to 56 basis points yesterday. The contracts have risen from below two basis points at the start of the credit crisis in July 2007. A basis point is 0.01 percentage point.

Credit-default swaps, contracts conceived to protect bondholders against default, pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements.

The U.S. economy will contract 2.05 percent in the fourth quarter, according to a Bloomberg survey, after shrinking by 0.5 percent in the previous three-month period.

The euro pared its gains before reports that may show money- supply growth and inflation are slowing in Europe, giving the European Central Bank more scope to cut interest rates.

Money Supply

M3 money supply, which the ECB uses as a gauge of future inflation, slowed to an 8.1 percent gain in October from an 8.6 percent increase the previous month, according to a Bloomberg News survey of economists before the central bank releases the data at 10 a.m. in Frankfurt today.

Consumer prices in the 15 countries that share the euro rose 2.4 percent in November, slower than a 3.2 percent gain the previous month, a separate report tomorrow may show.

The euro-area fell into a recession in the third quarter for the first time since the introduction of the common currency in 1999, data on Nov. 14 showed.

“The currency market is more focused on the bad economic outlook,” said Hideki Amikura, deputy general manager of foreign exchange at Nomura Trust and Banking Co. Ltd., a unit of Japan’s largest brokerage. “We may see euro selling on expectations for lower rates.”

Traders increased bets the ECB will reduce its 3.25 percent benchmark rate in the second quarter. The implied yield on Euribor futures contracts expiring in June fell to 2.45 percent from 2.91 percent at the end of last month. The ECB benchmark is 0.39 percentage point higher than the Euribor contract yield, compared with a 12-month average of 0.19 percentage point below.

To contact the reporter on this story: Stanley White in Tokyo at swhite28@bloomberg.netRon Harui in Singapore at rharui@bloomberg.net
Last Updated: November 27, 2008 01:12 EST