Dollar recovers from three-week low in technical rally

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The dollar rebounded from a three-week low on Friday, a day after the Federal Reserve kept U.S. interest rates on hold, in a late technical rally after a steep sell-off the previous session.

The Fed decision largely disappointed investors who wanted to get the process of normalizing rates going even at a gradual pace. It was largely expected though.

However, it was the Fed's dovish message, specifically the uncertain global growth outlook that could weigh on the world's largest economy, that took the market by surprise.

Market participants had anticipated two scenarios: a Fed hike with dovish undertones, or no move, but with upbeat comments about the U.S. economy.

Investors continued to sell the dollar earlier in the session before taking profits on their long positions in other currencies such as the euro and yen.

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"This is nothing more than a technical correction in the dollar," said Omer Esiner, chief market analyst at Commonwealth Foreign Exchange. "The Fed's decision has introduced heightened volatility in the market."

Markets have reduced expectations for a rate increase this year, which could dim the short-term outlook for the dollar.

Rates futures placed an 11 percent chance on Friday that the Fed would raise rates in October, down from 41 percent early on Thursday, according to CME Group's FedWatch program.

A December move by the Fed had a 42 percent chance, with traders putting a 52 percent probability for a rate increase at the Fed's late-January meeting.

In late trading, the dollar index was up 0.7 percent at 95.191, after dropping to a three-week low of 94.063.

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Some analysts expect the dollar to bounce back in the near term as soon as it becomes clear that the Fed is ready to end its zero-rate policy.

"With the Fed still projected to hike later this year, we expect the dollar to perform relative to currencies such as the euro, yen and sterling in coming months," said Allan von Mehren, chief analyst at Danske Bank in Copenhagen.

The prospect of loose monetary conditions for longer reignited investors' appetite for riskier currencies such as the Australian and New Zealand dollars, which gained.

The Australian dollar was up 0.3 percent against the greenback at US$0.7189, while the New Zealand dollar also rose 0.3 percent, to US$0.6400.

The euro was down 1.2 percent against the dollar at $1.1294 after hitting a three-week high of $1.1459.

Against the yen, the dollar was flat at 119.96 yen.