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Dollar up vs. Yen, Slips vs. Euro, Pound in Wake of Fed

The yen fell across the board Wednesday, after a Federal Reserve statement cooled expectations for a near-term U.S. interest rate cut and boosted stocks and other riskier assets.

The dollar at the same time declined against other major currencies because the Fed's statement Tuesday gave no indication of any near-term rate action, contrasting with central banks in Europe which have signaled rate rises this year.

In U.S. trade the dollar was up 0.8 percent at 119.70 yen, more than 2 yen up from this week's four-month low.

The euro was up 1.3 percent at 165.30 yen.

Against the dollar, the euro rose 0.5 percent percent to $1.3810 , less than half a cent below a record high hit in July.

The yen was also punished after data showed a surprisingly large drop in Japanese machinery orders in June, casting some doubt on a view that the Bank of Japan is likely to raise interest rates this month.

The dollar index, a measure of the greenback's value against a basket of six major currencies, was down a quarter of a percent, erasing most of its gains made in the previous session and heading back toward a 15-year low hit Monday.

Signs of a recovery in global investor appetite for risk, underscored in rising stocks, weighed on the low-yielding yen, a favorite vehicle for financing purchases of higher-yielding currencies in carry trading.

"Carry (trading) is moving in lockstep with stocks, so we're seeing a weaker yen," said Kathy Lien, senior currency strategist at DailyFX.com. "But as for the dollar, the divergence between the U.S. and euro-zone [interest rate] policy direction is continuing to hurt it against the euro."

In carry trades, investors borrow in low-interest-rate currencies such as the yen so they can invest in assets denominated in higher-yielding currencies such as the Australian dollar.

Carry trades tend to thrive when stock markets are heading higher and investors have a healthy appetite for risk.

Fed View

The Fed left interest rates on hold at 5.25 percent Tuesday, as expected, and acknowledged that financial markets have been volatile and credit conditions are becoming tighter for "some households and businesses."

In its monetary policy statement, Fed policy-makers reiterated that controlling inflation remains its number one policy concern and said that, despite the increase in risks to growth, the U.S. economy was still likely to expand at a moderate pace in coming quarters.

The statement sent stocks higher, U.S. government bonds down and emerging market spreads tighter in a sign that risk appetite is improving after a sharp deterioration over the past few weeks triggered by fears of a global credit shortage.

"In this benign environment carry trades are popular again, and the currencies that tend to lag are going to be those with either low interest rates or rates that are going nowhere, as opposed to European central banks which are moving higher," said Nick Bennenbroek, strategist at Wells Fargo in New York.

Financial markets had gone into the Fed meeting pricing in at least one quarter-percentage-point rate cut by the end of the year. They have since scaled that back to around a 75 percent probability of a single rate cut.

Euro, Sterling Rate Advantage Seen

The dollar will likely lose its interest rate advantage further in coming months, with the European Central Bank having already signaled it is likely to raise rates in September.

And the British pound rallied against the dollar on Wednesday, after a quarterly report from the Bank of England suggested U.K. interest rates may have to raise more to combat inflation.

The Australian dollar rose 0.8 percent against the U.S. dollar to US$0.8615 after the Reserve Bank of Australia raised interest rates a quarter point to 6.5 percent.

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