Dollar up on Fed taper view, Canadian dollar sinks

The dollar strengthened on Tuesday in tandem with U.S. Treasury yields, which rose on speculation the Federal Reserve would soon reduce its bond-buying stimulus further.

Developed market currencies were given a boost after the International Monetary Fund raised its global economic growth forecast to 3.7 percent in 2014 from 3.6 percent in October, its first increase in estimates in near two years.

Sha Ying | CNBC

Sterling gained 0.3 percent to $1.6474, following the IMF's forecast, which boosted Britain's growth forecast to 2.4 percent this year from the prior forecast of 1.9 percent. U.S. growth is now seen rising 2.8 percent rather than 2.6 percent.

The greenback climbed to its best level against the Canadian dollar in over four years. While the U.S. is on a path of reducing monetary stimulus from historic levels, expectations have grown that Canada's central bank is moving toward a path of looser monetary policy.

The Bank of Canada (BOC) is due to meet on Wednesday, where the current Reuters poll of economists expects no change to the 1 percent benchmark interest rate.

"The clear focus is on the BOC policy meeting tomorrow. I think there is a fair bit of speculation, mainly from U.S. and European banks that we could get an easing bias from the Bank of Canada tomorrow. I don't think they are anywhere ready to go that far," said Shaun Osborne, chief currency strategist at TD Securities in Toronto.

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"I think we have seen a fair amount of stimulus come into the economy from a weak Canadian dollar and there is just no rush at this point for the bank to make that step," he said, adding that the bank will likely want to keep its powder dry in order to keep the currency weak.

The U.S. dollar traded up 0.3 percent to C$1.0973 in mid-afternoon New York trade. It broke through a reported option barrier at C$1.10 hit a high of C$1.1019.

The euro fell to a low against the dollar of $1.3517 after Germany's ZEW economic sentiment indicator for January came in below forecasts. It was last trading at $1.3548, still down 0.10 percent on the day. Traders sold into rallies on expectations the European Central Bank will keep policy accommodative and may even cut rates if money markets tighten.


"The focus is more on the ECB's liquidity operations, and unless that is addressed, we expect the euro/dollar to remain a pain trade, staying in a range," said Geoffrey Yu, strategist at UBS.

The lost its gains on the yen while the dollar's advance on the Japanese currency was pared back. traded at 104.20 yen, up 0.04 percent after having been as high as 104.74 yen.

The dollar/yen pair has a robust correlation with rate-sensitive U.S. two-year yields. They rose after the Wall Street Journal said the Fed may announce a further reduction to its monthly bond purchases at its Jan. 28-29 policy meeting, to $65 billion from the current $75 billion.

"The report is not all that surprising but it did get the 10-year yield to move higher, but it is now moving back down," said Osborne of TD Securities.

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A reduction in the Fed's stimulus program would match the market expectations in a recent Reuters survey. Still, traders said the WSJ article helped to nudge the dollar higher against the yen.

"On the yen side, there is some positioning that the Bank of Japan may sound move dovish at the end of its policy meeting this week. We actually expect them to upgrade growth forecasts and that could actually see some correction in the dollar/yen in the short term. In the medium term, we expect the pair to rise," said Manuel Oliveri, FX strategist at Credit Agricole.

Key for the yen this week is the outcome of the Bank of Japan policy meeting on Wednesday. The BOJ is expected to retain a wait-and-see approach, having last year launched a massive stimulus program.

—By Reuters