Dollar Heads for Best Week in a Year on Fed Outlook

Sha Ying | CNBC

The U.S. dollar was headed for its biggest weekly gain in almost a year against major currencies on Friday after the Federal Reserve fueled expectations of an eventual end to ultra-loose U.S. monetary policy.

The euro fell to a two-week low against the dollar as interest rate differentials moved in favor of the U.S. currency and on a re-emergence of Greece's political turmoil.

The dollar surged and assets like stocks and bonds fell after Fed Chairman Ben Bernanke said on Wednesday the economy was improving enough for the central bank to begin scaling back its monthly $85 billion in asset purchases. That prompted traders to start pricing in an interest-rate hike in late 2014.

"We're very bullish right now on the U.S. dollar," said Michael Woolfolk, senior currency strategist at BNY Mellon in New York.

Woolfolk said the dollar is likely to gain regardless of Fed actions on tapering. If the economy improves and the Fed cuts back on its stimulus, the dollar will benefit from expectations of higher interest rates. But if the Fed maintains stimulus because the economy is weak, the dollar will rise on safe-haven demand, he said.

Against the currency basket, the dollar rose to 82.271, the strongest since June 6. It was last up 0.4 percent at 82.36 and was on track for a weekly gain of 2 percent, the biggest since early July, 2012.

Analysts said expectations of the Fed slowing the pace of its stimulus also led to a degree of uncertainty in financial markets, which will also boost the dollar.

"Players will likely park (assets) in the dollar until we have got a little more clarity about where the world is going," said Neil Jones, head of hedge fund FX sales at Mizuho Corporate Bank in London. "The dollar is benefiting from that and I sense it will continue to do so."

The euro fell to $1.3125, a two-week low.

Greece's Democratic Left party may pull out of Greece's ruling coalition on Friday after talks to resume state television broadcasts collapsed, plunging the nation into fresh turmoil. The news sent the country's borrowing costs to their highest since April.

Traders said with the yield gap between 10-year Treasuries and German Bunds rising to its highest since late April 2010 in favor of the former, investors were looking to initiate fresh bets against the euro.

The last time spreads between U.S. Treasures and benchmark German Bunds were at that level over three years back, the euro started to fall from a high of above $1.34 to below $1.20.

The dollar gained 0.5 percent against the yen to 97.71 yen, near its 98.28 yen top hit on Thursday.

"Demand from Japanese investors for Treasuries will pick up and we are expecting the U.S. economy to keep growing. The Fed is likely to start tapering (stimulus measures) in September and this is very encouraging for dollar/yen," said Yujiro Goto, FX strategist at Nomura.

Some traders said higher U.S. interest rates could prompt a stampede out of emerging markets. Such a development could favor traditional safe-haven currencies such as the yen and the Swiss franc.