Dollar slips on dovish Fed remarks, China hopes help euro

By Herbert Lash and Harry Robertson

NEW YORK/LONDON (Reuters) -The euro strengthened as the dollar slid on Tuesday in response to a sharp drop in Treasury yields on the back of further dovish comments by Federal Reserve officials, as well as the prospect of stimulus from China.

The benchmark 10-year Treasury note tumbled to a day low of 4.618% from Monday’s high of 4.887% after Atlanta Fed President Raphael Bostic said the U.S. central bank does not need to increase interest rates any further.

Bostic, in the latest comments this week by Fed speakers, told the American Bankers Association that Fed policy is sufficiently restrictive and that he sees no recession ahead even as the Fed’s rate hikes slow the economy and bring down inflation.

Bostic was partly responding to the outburst of violence in Israel and Gaza, said Joseph Trevisani, senior analyst at FXStreet in New York.

“You’re looking at the typical and standard and historically repeated reaction of the Fed to a crisis that (would) lower rates if things get ugly in the Middle East,” he said.

“You can pretty much count on the Fed taking that into its world view and that’s only going to be lower rates.”

U.S. Treasuries rallied, pushing two-year yields to their lowest in a month, as safe-haven demand was driven by the ongoing Mideast bloodshed and dovish Fed comments.

The euro rose 0.3% against the dollar to $1.0604, while the dollar index, a measure of the U.S. currency against six others, slid about 0.19% to 105.75, well below last week’s 11-month high of 107.34, after touching the lowest level this month.

“The focus on term yields and term premiums is going be a key issue for the U.S. dollar because it does suggest that maybe the Fed doesn’t have to go any more,” said Shaun Osborne, chief FX strategist at Scotiabank in Toronto.

“These are all things that are going to check the dollar’s advance. Whether we see any sort of significant decline at this point, it’s hard to say given where yields are,” he said.

Traders awaited the release on Wednesday of minutes from the Fed’s last policy move as well as key U.S. inflation data on Thursday. Investors also are keeping a close eye on the conflict between Israel and the Palestinian Islamist group Hamas, though the initial safe-haven purchase of the dollar has stopped.

Bloomberg reported that China is weighing the issuance of at least 1 trillion yuan ($137.1 billion) of additional sovereign debt for spending to boost its struggling economy. Analysts said this helped currencies such as the euro, which are more exposed to global growth.

U.S. bond yields dropped sharply on Tuesday when trading reopened following the Columbus Day holiday. The fall in global borrowing costs helped boost Asian and European stocks.

The yen weakened 0.13% versus the greenback to 148.68 per dollar. Japan’s currency bounced after the Kyodo news agency reported that the Bank of Japan is considering raising its forecast for core consumer inflation this year, but then gave up its gains.

Analysts said the drop in U.S. yields was initially driven by comments from two Fed officials on Monday who said rising long-term yields might negate the need for further hikes, and by traders seeking out safe-haven assets after the Hamas assault on Israel.

The yield on the 10-year U.S. Treasury, which moves inversely to the price, was down 12.5 basis points at 4.6571%. It hit its highest since 2007 last week at 4.887%.

Israel’s shekel traded at 3.9550 to the dollar, just off an almost eight-year low hit on Monday, after the central bank pledged $30 billion to stem the sell-off in the currency.

“They’re firmly engaged here, and I think they want to stop it from trading at that 4 level,” said Chris Turner, head of markets at ING.

Israeli air strikes hammered Gaza on Tuesday, razing entire districts and filling morgues with dead Palestinians as Israel took revenge for the Hamas assaults.

The Swiss franc, a traditional safe-haven currency, was at 0.9045 to the dollar, which weakened about 0.21%. Britain’s pound was up 0.40% at $1.2286.