Dollar Falls after Fed Acts on Credit Turmoil

The dollar fell broadly Friday after the Federal Reserve slashed the interest rate it charges on loans to banks, and said economic growth could slow in light of tightening credit markets.

The dollar was pulling back from a seven-week high against a basket of major currencies on Thursday after investors sought the safety of the currency and of U.S. Treasuries during the week in the midst of a global stock rout.

The Fed's action, while alleviating some fears about U.S. lending conditions, dealt a blow to the greenback since many speculated the central bank could be on a path to lower its benchmark interest rate, thereby reducing the dollar's yield advantage.

"By no means is this positive to the dollar," said Gregory Salvaggio, a senior currency trader at Tempus Consulting in Washington. "Actually, this is the two-headed monster for the buck: lower interest rates and slower growth."

By early afternoon, the euro was 0.5 percent higher at $1.3491, on pace for the biggest gain in a month.

The dollar index, which tracks the dollar's performance versus a basket of currencies, was down 0.5 percent to 81.283.

Against the yen, the dollar was flat at 114.22 yen, while the euro climbed 0.8 percent to 154.54 yen.

The dollar has racked up the biggest weekly decline since early March against the yen because of a massive unwinding of what had been the most dominant strategy in the currency market, in which investors borrow cheaply in one currency to buy higher-yielding assets.

Investors rushing for the exit from so-called carry trades have pummeled currencies with relatively high interest rates. The New Zealand dollar slid 10 percent against the yen this week to 79.50 yen (NZDJPY-R), the largest weekly decline since October 1998.

The euro is off 4.5 percent this week against the yen, the biggest weekly loss in four years.

Wobbly Carry Trade

Japanese retail currency investors trading on margin -- a stalwart force in keeping the yen weak -- halved their bets against the yen this week, JPMorgan analysts said in a note.

Their aggregate short position shrunk this week to 3.3 trillion yen from 6.9 trillion yen as of Monday.

The Fed's action has certainly slowed the unwind of carry trades from its torrid pace on Thursday, but market strategists said high-yielding currencies, particularly in emerging markets, are still at risk.

"The market volatility will remain high despite today's Fed move," said economists with Standard Chartered in New York.

"Emerging market currencies will find comfort in today's move, as will carry positions in general. But we do not believe the shakeout in emerging market currencies is over just yet," they said.

The British pound has been hard hit this week, falling around 2 percent to $1.9823, the largest weekly decline in almost a year. The pound had been a favorite of dealers because of its relatively high interest rate.

Analysts have said this week that fund managers have likely had to pare back profitable positions to pay off margin calls from their banks, and as a result the pound may been a casualty.

Earlier on Friday, the Fed cut its discount rate by a half-percentage point to 5.75 percent in an attempt to increase liquidity and said it was monitoring market conditions.

"Financial market conditions have deteriorated, and tighter credit conditions and increased uncertainty have the potential to restrain economic growth going forward," the Federal Open Market Committee, the central bank's policy-making arm, said in a statement.