Dollar Rebounds as Traders Bet on Steady Interest Rates

The dollar rose sharply, recouping the prior session's decline, on the view that the Federal Reserve may hold rates steady for some time.

The Fed on Wednesday left rates at 5.25% but dropped language used in earlier policy statements that signaled it was more inclined to tighten credit to choke off inflation than to cut rates to promote growth.

The shift in language had pushed the greenback to a two-year low against the euro as markets interpreted it to mean a rate cut may be near.

But today, the market re-evaluated the statement.

Analysts emphasized that the Fed also reiterated that it was keeping a close eye on inflation, a stance that could suggest the central bank saw no need to rush a rate cut.

"The market realized it overdid the (dollar) selling yesterday, as markets often do, and now we're seeing some pretty serious profit-taking," said Joseph Trevisani, chief market analyst at FX Solutions in Saddle River, New Jersey.

Recent worries about the health of the U.S. economy, including soft manufacturing data and rising defaults in home loans to borrowers with impaired credit, have weighed on the dollar. Even so, analysts said the Fed's change of tone suggests the central bank is making sure it steers the economy into a soft landing.

That has helped boost global equities and prompt investors to wade back into so-called carry trades, which involve borrowing low-yield currencies such as the yen to buy assets with higher yield -- and higher risk -- including equities.

Meanwhile, the high-yielding Australian dollar hit a fresh 10-year high of US$0.8087 . Investors expect Australia's central bank to raise rates as early as next month.

"The carry trades have come back in favor again, with the equity markets warming up a little bit to the Fed. That suggests investors are generally not risk-averse at the moment, that they are putting money back into the carry trade," said Shaun Osborne, chief currency strategist with TD Securities in Toronto.

Jobless Claims Help

The dollar also got a lift from a report showing the number of people filing new claims for jobless benefits unexpectedly fell last week to its lowest in six weeks, boosting the view that the labor market is healthy.

Trevisani said strong employment data is easing fears that defaults on subprime mortgages will damage the broader housing market by limiting access to credit and slowing consumer spending.

"To me, jobs growth that's still at a healthy level is the more important indicator," he said. But he said a move in the euro back to the $1.30 area seen earlier this year was not likely until unease about the U.S. economy dissipates further.

A clutch of Fed officials, including Chairman Ben Bernanke and Vice Chairman Donald Kohn, spoke at a conference on credit derivatives on Thursday, though none of them addressed the economic outlook or monetary policy.

But a senior Fed staffer, in prepared remarks to the Senate Banking Committee, said the Fed was not seeing signs that problems in the subprime mortgage market were spreading to other market segments.