Euro Rallies From 3-Week Lows Against Dollar

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The euro hit session highs on Monday, rallying from nearly three week lows, in tandem with U.S. stocks paring their losses and commodities gaining sharply.

The euro rose as high as $1.3143, recovering from lows of $1.3058, its weakest level since June 5. It was last at $1.31327, up 0.1 percent.

"We're seeing a stemming of the sell-off in risky assets and that has caused some mild profit-taking on the dollar," said Joe Manimbo, senior market analyst at Western Union Business Solutions in Washington.

Earlier, the U.S. dollar rallied to its highest in nearly three weeks against a basket of currencies on rising expectations U.S.monetary stimulus will be scaled back in the near term.

The shift in sentiment has prompted investors to unwind bets that the Federal Reserve was not ready to end its bond-buying program, known as quantitative easing. The unwinding, however, could take months.

Though the dollar was not up across all pairs on Monday, it has been since Fed Chairman Ben Bernanke said last Wednesday that the U.S. central bank could taper its monthly $85 billion in asset purchases if the economy continues to improve. U.S. bonds and stocks have sold off since the Fed announcement.

"The optimism by the Fed fell in sharp contrast to other prominent central banks, such as the Bank of Japan, Bank of England, European Central Bank, and Reserve Bank of Australia, which are seeking measures to thwart a further economic slowdown to their respective jurisdictions,"said Ravi Bharadwaj, market analyst at Western Union Business Solutions in Washington.

The dollar index was steady at 82.40, around its highest since June 5. The index rallied 2.2 percent last week, its biggest weekly rise since November 2011.

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Bernanke's comments have helped push up the benchmark 10-year U.S.Treasury note's yield to its highest in almost two years on Monday with interest rate differentials moving in favor of the dollar. U.S. 10-year yields were at 2.52 percent in afternoon trading.

The dollar shifted between gains and losses against the yen, but sold off in the New York session as investors considered that the recent five-day advance had gone too far, too fast. It had risen earlier against the Japanese currency after Bank of Japan Deputy Governor Kikuo Iwata said the central bank still has options for monetary easing, if need be.

In early afternoon trading, the dollar was down 0.2 percent at 97.68 yen, below an earlier peak of 98.70, its highest since June 11.

The euro was supported by a survey showing a small increase in German business morale, which helped keep the single currency above key chart support.

Rate differentials between 10-year Treasury notes and similarly-dated German Bunds have moved in favor of the former, with spreads at their highest since April 2010.

Analysts at Morgan Stanley, who recently recommended selling the euro with a target of $1.28, have lowered their entry level for the trade to$1.3180. A sustained break below the 200-day moving average, currently at$1.3072, would be a bearish signal, they said.

The euro also fell 0.2 percent to 128.22 yen.

"These flows reflect the repositioning toward a new Fedreality and begin a new trend for the U.S. dollar," said Camilla Sutton,Chief FX Strategist at Scotiabank in Toronto. "The violence of the marketmoves should begin to settle in the coming weeks."

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Changes in the price of the dollar against the yen were mostly inresponse to moves in European stocks. After investors digested comments fromthe BoJ's Iwata, the dollar surrendered gains as investors traded on otherfactors.

Iwata, a vocal advocate of reflationary policies, said if the BoJwere to boost asset purchases in the future, he would favor government bondsover risky assets, given the size of the vast market for Japanese governmentbonds, or JGBs.

The BoJ stunned financial markets on April 4 by setting in motionan intense burst of monetary stimulus, promising to double its bond holdings intwo years and boost purchases of risky assets in an attempt to jolt the economyout of deflation.

Volume picked up in the New York session, with $3.6 billion in euros changing hands globally by early afternoon trading, using Reuters Dealing data. Some $2.3 billion in yen traded.

The higher-yielding Australian dollar, which is sensitive to concerns about growth in China, recovered from an earlier 33-month low. The Australian dollar was steady at US$0.9279 after falling as low as $0.9145.

A recent spike in inter bank borrowing costs have raised fears that stress in China's banking system could weigh on already slowing growth.